$25.

95
W
hat are the appropriate pub4c policies
for America as it approaches the com
ing century? The signs are all around.
A market-liberal revolution is sweeping the
planet, fom Easter Europe t Latin America
to Asia, where governments are selling off
state enterprises, cutting taxes, deregulating
business, and showing new respect for prop
erty rights and freedom of choice. The two
dozen essays in this book discuss how t bring
the market-liberal revolution to the United
States and explain
how for-proft companies wlrevolu
tionize education,
how deregulation of mecal care can
lower prices,
how America can save $l5Obillion a
year in militar spending,
how property rights can f the
environment,
how deregulation and fee trade
produce prosperity,
how competition produces health
and safety,
how America must deal with nuclear
proliferation,
how we can balance the budget without
raising taxes,
how the povert and welfare trap C
be ended, and
how the inner cities can become
livable again.
This blueprint for reform is the alterative
to both the status quo and the calls for even
more goverent iterference in our personal
(continued on back fap)
\m
HI
A Paradigm for tie
21
s t
Century
edited by
David Boaz and Edward H. Crane
I NSTI TUTE
Washington, D.C.
Copyright ! 1993 by the Cato Institute.
All rights reserved.
LDtt u1 LuH_tC55 Ltu_H_-H-1UDCtuH t
Market liberalism : a paradigm for the 21st century edited by David
Boaz and Edward H. Crane.
p. cm.
Includes bibliographical references.
ISBN 0-932790-98-4 (cloth) : $25.95.-ISBN 0-932790-97-6 (pbk. ) :
$15. 95
1 . United States-Politics and government-1993- 2. Liberalism
United States. 3. Free enterprise-United States. I. Boaz, David,
1953- . II. Crane, Edward H. , 1944-
E885. M37 1993
320. 5'I-dc20
92-42550
Cover Design by Colin Moore.
Printed in the United States of America.
CA T M5TITLTI
224 Second Street, S. E.
Washington, D. C. 20003
CIP
Contents
1 . Introduction: The Collapse of the Statist Vision
David Boaz and Edward H. Crane 1
PART I AN AMERICAN VISION
2. Freedom, Responsibility, and the Constitution:
On Recovering Our Founding Principles
Roger Pilon 21
3. Reclaiming the Political Process
Edward H. Crane 53
PART II ECONOMIC POLICY
4. Balance the Budget by Reducing Spending
William A. Niskanen and Stephen Moore 67
5. Reduce Federal Regulation
William A. Niskanen 103
6. Government Regulation: The Real Crisis in
Financial Services
Bert Ely 115
7. Telecommunications: Starting the Next Century
Early
Thomas W. Hazlett 129
PART III DOMESTIC POLICY
8. Social Security's Uncertain Future
A. Haeworth Robertson 149
9. The Learning Revolution
Lewis J. Perelman 159
10. Returning Medicine to the Marketplace
Michael Tanner 175
1 1 . Reviving the Inner City
David Boaz 189
12. Privatizing Essential Services
Robert W. Poole, Jr. 205
PART IV INTERNATIONAL AFFAIRS
13. Taking the Offensive in Trade Policy
Brink Lindsey 227
14. Rethinking NATO and Other Alliances in a
Multipolar World
Christopher Layne 243
15. Learning to Live with Nuclear Proliferation
Ted Galen Carpenter 259
16. A Post-Cold War Military Budget
Jeffrey R. Gerlach 277
17. Dangerous Panacea: A Stronger United Nations
Doug Bandow 293
18. Time to Retire the World Bank and the
International Monetary Fund
Melanie S. Tammen 311
19. Ending Washington's In tern a tional War on
Drugs
Ian Vasquez 325
PART V ECOLOGY
20. Global Warming: Facts vs. the Popular Vision
Patrick]. Michaels 341
2l . The Growing Abundance of Natural Resoures
Jerry Taylor 363
22. Why Health and Safety Are Products of
Competitive Institutions
Aaron Wildavsky 379
2. AFree-Market Environmental Vision
|teJL. 5mit|,]t., enJKent]qqs
Contributors
39
43
1 . Introduction: The Collapse of the
Statist Vision
David Boaz and Edward H. Crane
The history of the West is largely a history of liberty. Antigone,
Jesus, the emergence of pluralism and independent cities, the
Magna Carta, the Renaissance, Martin Luther, the Enlightenment,
the American Revolution, the repeal of the Corn Laws, the abolition
of slavery, all mark continued progress toward the liberation of the
individual from the coercive power of the state.
The 19th century seemed the culmination of that progress, a time
when, according to the Nation in 1900, "Freed from the vexatious
meddling of governments, men devoted themselves to their natural
task, the bettering of their condition, with the wonderful results
which surround us. " But at the end of that great century of peace,
progress, and industrial revolution in Europe, when the triumph
of liberty seemed almost complete, many liberals saw the ancien
regime returning in a new guise. Herbert Spencer warned of "the
coring slavery," and the Nation worried that "before [statism] is
again repudiated there must be international struggles on a terrific
scale. " The liberals' fears were realized; the 20th century has been
a century of war and statism on an unprecedented scale. Totalitarian
ideologies gave the state a legitimacy it had lost, and technology
enabled governments to practice mass murder. Great Britain and
the United States were spared the horrors of Nazism and commu
nism, but some of the same nationalist, technocratic, and statist
impulses lay behind the growth of the welfare-warfare state in
those countries.
To be sure, the 20th century has not been an unmitigated disaster.
The promises of the Declaration of Independence, the Constitution,
and the Civil War Amendments were at last extended to all Ameri
cans, and in many ways Americans have more choices available to
them than any other people in history. Though the federal govern
ment grew to be the wealthiest entity in human history, and its
1
MARKET LIBERALISM
tax collectors and regulators sought to intrude in our economic
lives in a detailed way never before imagined, still the productive
powers of the marketplace steadily raised all Americans to an
. unprecedented standard of living.
Yet by the late 20th century, in the West and elsewhere, govern
ments had become huge, stultifying institutions-bureaucratic
socialism in Russia and Eastern Europe, autocracy in Latin America,
totalitarian despotism in Asia, kleptocracy in Africa, and tax-and
spend welfare states in the West.
Then, by the last quarter of the century, just as liberals might
have despaired of ever returning to the path of progress toward
liberty that had characterized Western history until this century,
the trend began to turn. Many countries in Latin America threw
out their military rulers, established democratic governments, and
began privatizing state enterprises and opening protected indus
tries to global competition. The rulers of China noticed how pros
perous the Chinese people were becoming in every society but
their own and quietly began to privatize agriculture in the world's
most populous country, setting in motion one of the world's fastest
growing economies. Great Britain privatized hundreds of state
enterprises large and small and introduced an element of competi
tion into the stodgy bureaucracies of health and education. Mikhail
Gorbachev opened the Pandora's box of glasnost and was no doubt
surprised at what he eventually discovered inside. His tentative
reforms led rapidly to the most significant change of the late 20th
century, the collapse of European communism and the still-in
progress liberation of the people of Russia and Eastern Europe.
Even in Africa, a generation after the end of colonialism, the first
steps toward democracy and markets are beginning to be seen.
In other corners of the world, from Pretoria to Auckland, from
Stockholm to Taipei, a liberal revolution is once again bringing free
markets and human rights to the people of the world.
And yet it seems that after a few tentative steps toward deregula
tion in 1978 and tax reduction in 1981, the free-market revolution
in the United States has failed to stop the inexorable growth of the
omnivorous federal government. In 1940 the federal government
spent $13 billion; today the figure is $1 . 5 trillion, an increase of
over 10, 000 percent (see Figure 1 . 1) . Thomas Jefferson said 200
years ago that "the natural progress of things is for liberty to yield
2

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MARKET LIBERALISM
and government to gain ground," and today's Jeffersonians are
recognizing anew the truth of his observation. It's clear that Ameri
cans are dissatisfied with the state of their government. In the
1992 presidential primaries many of them voted for candidates
promising radical change, even when the nature of that change
wasn't clear. Despite a reelection system that had seemed impervi
ous to challenge, an unprecedented number of congressional
incumbents either retired under pressure or were defeated, and
term limitation showed the most broad-based support of any politi
cal movement in a generation. Almost 20 million Americans voted
for a presidential candidate whose chief qualifcation seemed !O be
that he had never been in politics.
But despite the demand for change, there seemed to be no clear
conception of j ust what kind of change was needed. People knew
the system wasn't working; they weren't sure what ought to replace
it, but the trend clearly wa. s against seeking government solutions.
The 93 percent reelection rate for incumbents in November's con
gressional elections, rather than being an endorsement of the status
quo, seemed to justify the 14-state sweep of term limit initiatives.
Nine of 10 state tax increase initiatives went down in flames, while
six of eight tax or spending limitation measures were approved.
Voters in California overwhelmingly rejected a mandated health
insurance proposal, and environmental regulatory initiatives were
defeated in Massachusetts and Ohio. Indeed, exit polls revealed
that a substantial majority of Americans preferred lower taxes even
if it meant less in the way of government services.
The World Is Too Much Governed
The real problem in the United States is the same one being
recognized all over the world: too much government. The bigger
the government, the bigger the failure; thus state socialism was the
most obvious failed policy. As liberals warned throughout the 20th
century, socialism faced several insurmountable problems: the
totalitarian problem, that such a concentration of power would be
an irresistible temptation to abuse; the incentive problem, the lack
of inducement for individuals to work hard or efficiently; and the
least understood, the calculation problem, the inability of a socialist
system, without prices or markets, to allocate resources according
to consumer preferences. For decades liberals such as F. A. Hayek
4
Introduction
and Ludwig von Mises insisted that socialism simply couldn't work,
couldn't effectively utilize all the resources and knowledge of a
great society to serve consumers. And for decades social democrats
in the West sneered that not only was Soviet communism surviving,
the USSR's economy was growing faster than the economies of the
West. The social democrats were wrong, in many ways. First, some
scholars have argued that the Soviet Union gave up true Marxist
socialism in 1921, after the devastating failure of the War Commu
nism years, and thereafter operated a crude kind of market econ
omy with massive government intervention. ! Second, though the
clumsy Soviet economy could produce large quantities of steel, it
never managed to produce anything that consumers wanted. By
the late 1980s the Soviet economy was not two-thirds the size of
the U. S. economy, as the CIA estimated; it did not "make full use
of its manpower," as John Kenneth Galbraith said; it was not "a
powerful engine for economic growth," as Paul Samuelson's text
book told generations of college students. It was, in fact, about 10
percent the size of the U. S. economy, as nearly as such disparate
things can be compared, and it made grossly inefficient use of the
educated Soviet workforce. A failure in the industrial age, it was
a dinosaur in the information age, a fact obvious to everyone
except Western intellectuals-who visited the USSR.
Similarly obvious were the gross human rights abuses and eco
nomic inefficiencies of apartheid in South Africa and the stagnation
of the coddled, debt-ridden economies of Latin America and New
Zealand. Because our own government never amassed as much
power as did those foreign regimes, the failure of big government
here at home was never as clear. Still, the U. S. government has
become a Leviathan that Thomas Jefferson would never recognize.
No institution in history has ever commanded as much wealth as
the u.s. government. As recently as 1920 government spending at
all levels amounted to just 10 percent of national income. By 1950
that percentage had soared to 26 percent. Today the figure is about
ISee Paul Craig Roberts, Alienation and the Soviet Economy (Albuquerque: University
of New Mexico Press, 1971); Don Lavoie, Rivalry and Central Planning: The Socialist
Calculation Debate Reconsidered (Cambridge: Cambridge University Press, 1985); Paul
Craig Roberts and Karen LaFollette, "The Original Aspirations and the Soviet Econ
omy Today," in Meltdown: Inside the Soviet Economy (Washington: Cato Institute,
1990).
5
MARKET LIBERALISM
4 percent, and government spending rose faster under President
Bush than it had under any president in a generation. Government
employment rose from 3. 9 million in 1933 to 18. 4 million in 1992.
Government is by far the biggest employer and the biggest landlord
in our society. A visit to any state capital-not just Albany or
Sacramento but Richmond or Frankfort-will confirm that state
governments, too, have become massive, costly enterprises.
The cost of all this government can be measured, imprecisely to
be sure, in economic terms. In 1950 the average family paid only
2 percent of its income to the federal government; today the same
family pays 25 percent. Government expenditures at all levels
amount to about $20,000 per household. Taxes add about 70 percent
to the price of the goods we buy. As William Niskanen points out
in chapter 5 of this volume, regulation costs the economy about
$600 billion a year in lost output. The growth of taxes and regulation
over the past generation and the declining quality of government
schools have given us 20 years of slow economic growth-a burden
that is more easily borne by the upper middle class than by people
still struggling to achieve a comfortable standard of living.
But the cost of government should not be measured exclusively
in economic terms. Democratic governments today presume to
regulate more aspects of our lives more closely than even the auto
cratic governments of the ancien regime ever did. Governments in
the United States assign our children to schools and select the
books they will learn from, require us to report our most intimate
economic transactions, demand 80 permit applications if we want
to start a business in Los Angeles, restrict whom we may sleep
with and what we may read, prescribe the number and gender
ratio of toilets in buildings open to the public, tell us whom we
must hire and whom we may fire, bar our most efficient businesses
from high-tech markets, regulate the size of the oranges we may
buy, deny terminally ill patients access to pain-relieving and life
saving drugs, strangle our financial institutions with archaic rules,
prosecute investors for crimes that have never been defined, and
devote 19, 824 words to a directive on the U. S. peanut program.
And, though it rarely comes to this in civilized modern societies,
it should be remembered that behind every ridiculous regulation
stands the government's willingness to enforce it with violence if
necessary.
6
Introduction
Thus, the cost of government must finally be measured in free
dom. Regulations-from drug laws to anti-discrimination laws to
occupational licensing-restrict our freedom to make our own
choices. Anti-pornography ordinances, hate-speech codes, and
government entanglement in the arts limit our freedom of expres
sion. Compared with the long-suffering people of Russia, or South
Africa, or Peru, or China, Americans enjoy a great deal of free
dom-but if Thomas Jefferson returned to Washington in 1993 he
would surely say that, like George III, our government today has
erected a multitude of new offices and sent hither swarms of officers
to harass our people and eat out their substance.
Tocqueville warned us of what might happen.
After having thus successively taken each member of the
community in its powerful grasp and fashioned him at will,
the government then extends its arm over the whole com
munity. It covers the surface of society with a network of
small, complicated rules, minute and uniform, through
which the most original minds and the most energetic char
acters cannot penetrate, to rise above the crowd. The will
of man is not shattered, but softened, bent, and guided;
men are seldom forced by it to act, but they are constantly
restrained from acting. Such a power does not destroy, but it
prevents existence: it does not tyrannize, but it compresses,
enervates, extinguishes, and stupefies a people, till each
nation is reduced to nothing better than a flock of timid
and industrious animals, of which the government is the
shepherd. 2
Charles Murray has examined the way the welfare state takes
over the responsibilities of individuals and communities and in
the process takes away much of what brings satisfaction to life. If
government is supposed to feed the poor, then local charities aren't
needed. If a central bureaucracy downtown manages the schools,
then parents' organizations are less important. If government agen
cies manage the community center, teach children about sex, and
care for the elderly, then families and neighborhood associations
feel less needed. As Murray puts it, "When the government takes
away a core function [of communities], it depletes not only the
2Alexis de Tocqueville, Democracy in America, part 2 (180), book 4, chap. b, "What
Sort of Despotism Democratic Nations Have to Fear. "
7
MARKET LIBERALISM
source of vitality pertaining to that particular function, but also the
vitality of a much larger family of responses.
,,
3 If the citizen knows
that government will feed the hungry if the local church doesn't,
he's less likely to get involved in the church project. Soon "let the
government take care of it" becomes a habit. Today's communitari
ans sense that problem, though they tend too often to envision
communities' working through government rather than through
voluntary efforts.
A New Vision for America
To make sense of the American people's dissatisfaction with
the present state of affairs, we need a new vision for American
government, a vision rooted in the principles of our Founders and
suited to the challenges of the 21st century. In this book we propose
such a vision, one that we call market liberal. Today people in the
United States and around the world who believe in the principles of
the American Revolution-individual liberty, limited government,
the free market, and the rule of law-call themselves by a variety
of terms, including conservative, libertarian, classical liberal, and
liberal . We see problems with all those terms. "Conservative"
smacks of an unwillingness to change, a desire to preserve the
status quo. Only in America do people seem to refer to free-market
capitalism-the most progressive, dynamic, and ever-changing
system the world has ever known-as conservative. In addition,
many contemporary American conservatives favor state interven
tion in trade, in our personal lives, and in other areas. "Libertarian"
is an awkward and misinterpreted neologism that has become too
closely tied to a particular group of activists.
"Classical liberal" is closer to the mark, but the word "classical"
connotes a backward-looking philosophy all the tenets of which
have been carved in stone. Finally, "liberal" may well be the perfect
word in most of the world-the liberals in societies from China to
Iran to South Africa to Argentina are supporters of human rights
3
Charles Murray, In Pursuit: Of Happiness and Good Government (New York: Simon
& Schuster, 1988), Q. 274.
8
Introduction
and free markets4-but its meaning has clearly been corrupted by
contemporary American liberals.
"Market liberal, " by modifying liberal with an endorsement of
the free market, thus strikes us a solid description of a philosophy
that is rapidly gaining adherents throughout the world. It is a
forward-looking philosophy, comfortable with a changing world,
tolerant, and enthusiastic about the market process and individual
liberty.
The market-liberal vision brings the wisdom of the American
Founders to bear on the problems of today. As did the Founders, it
looks to the future with optimism and excitement, eager to discover
what great things women and men will do in the coming century.
Market liberals appreciate the complexity of a great society, recog
nizing that socialism and government planning are just too clumsy
for the modern world. It is-or used to be-the conventional wis
dom that a more complex society needs more government, but the
truth is just the opposite. The simpler the society, the less damage
government planning does. Planning is cumbersome in an agricul
tural society, costly in an industrial economy, and impossible in the
information age. Today collectivism and planning are outmoded,
backward, a drag on social progress.
Market liberals have a cosmopolitan, inclusive vision for society.
We reject the bashing of gays, Japan, rich people, and immigrants
that contemporary liberals and conservatives seem to think
addresses society's problems. We applaud the liberation of blacks
and women from the statist restrictions that for so long kept them
out of the economic mainstream. Our greatest challenge today is
to extend the promise of political freedom and economic opportu
nity to those who are still denied it, in our own country and around
the world.
As visionaries such as Warren Brookes and George Gilder have
pointed out, we stand today at the dawn of a new era in history.
Gilder writes, "Capital is no longer manacled to machines and
places, nations and jurisdictions. Capital markets are now global
and on line twenty-four hours a day. People-scientists, workers,
4Michael Dobbs reported from Moscow in the Washington Post on September 1,
1992, that "liberal economists have criticized the government for failing to move
quickly enough with structural reforms and for allowing money-losing state factories
to continue churning out goods that nobody needs."
9
MARKET LIBERLISM
and entrepreneurs-can leave at the speed of a 747 . . . Companies
can move in weeks. Ambitious men need no longer stand still to
be fleeced or exploited by bureaucrats. Geography has become
economically trivial . "s (Richard McKenzie and Dwight Lee
described an extreme example of that: about half a billion dollars
was faxed out of Kuwait City on the afternoon of August 2, 1990,
as the Iraqi army approached. )
6
National boundaries are becoming
irrelevant, increasingly ineffective obstacles to trade among entre
preneurs in different parts of the world. The successful economies
of the 21st century will be those of countries that liberate their
people. Human capital-knowledge, creativity, and entrepreneur
ship-is the key to prosperity in the information age.
One of the exciting results of the information age, as Jerry Taylor
points out in chapter 21, is that our more productive, high-tech
economy uses far fewer natural resources to provide a higher stan
dard of living. Tiny silicon chips have replaced bulky vacuum tubes
and transistors, and fiber optics and satellites are replacing thou
sands of miles of copper cable. That's one reason natural resources
are 20 percent less expensive today than they were in 1980, 50
percent cheaper than in 1950, and 80 percent cheaper than in 1900. 7
As central governments become larger, more intrusive, more
impervious to political change, and more irrelevant to economic
progress, people in many parts of the world-Quebec, Croatia,
Bosnia, northern Italy, Scotland, and much of Africa, not to mention
the 15 new republics of the old Soviet Union-are challenging the
nation-states that they find themselves in. Governments respond
to dissatisfaction by trying to set up a new world order or a unified
Europe. The European Community, which began as an attempt to
SGeorge Gilder, Microcosm: The Quantum Revolution in Economics and Technology
(New York: Simon & Schuster, 1989), pp. 355-56. See also Floyd Norris, "Why
Currencies Move Faster Than Policies," Ne York Times, September 23, 1992, p. 01:
The exchange-rate turbulence of mid-September "provided a bitter reminder to
central bankers and finance ministers around the world that the power of govern
ments to control economies and currencies has eroded. "
6Richard B. McKenzie and Dwight R. Lee, "Government i n Retreat," National
Center for Policy Analysis Policy Report no. 97, June 1991, p. 4. See also Richard
B. McKenzie and Dwight R. Lee, Quicksilver Capital: How the Rapid Movement of
Wealth Has Changed the World (New York: Free Press, 1991).
7
Stephen Moore, "So Much for 'Scarce Resources,'" Public Interest no. 106 (Winter
1992): 98.
10
Introduction
make trade flow freely throughout the Continent, now pays five
times the world market price to rich European farmers and regulates
the content of cheese and the size of condoms.
What the world needs instead of greater centralization is further
progress toward free trade and devolution of government decision
making to smaller units. The ideal arrangement for many parts of
the world might be very small nations linked by open borders and
in some cases by federal governments organized for defense and the
protection of individual rights. The United States and Switzerland
provide imperfect models for such a structure, which would give
maximum opportunity for individuals to vote with their feet and
force local communities to bear the costs of their own decisions.
Scotland and Slovakia have both demanded more subsidies for
their uncompetitive industries from the more productive English
and Czechs; chances are an independent Slovakia will soon realize
the advantages of Czech prime minister Vaclav Klaus's free-market
reforms when the Slovaks have to pay all the costs of doggedly
trying to stay semisocialist. An independent Scotland might well
discover the same thing. As a sort of thought experiment, one
might even speculate about what kinds of policies an independent
South Central Los Angeles might pursue. Rep. Maxine Waters can
declare her constituents victims-as they are, to some extent, as
David Boaz argues in chapter l 1-and demand more money from
taxpayers in Kansas and Connecticut; President Maxine Waters just
might be forced to try free markets in order to create wealth right
there in her independent republic. One of the most important
checks on the power of wrong-headed governments is open borders
for capital, goods, and people.
The market-liberal order requires a stable rule of law that protects
private property rights, as Roger Pilon points out in chapter 2. In
a culture that sanctions legal plunder and rewards individuals for
being irresponsible, there will be a general lack of respect for law,
liberty, and justice. Public policies supportive of private property
and the rule of law, in turn, rest on cultural values. It is therefore
essential for leaders in all fields-not just public offcials but teach
ers, lawyers, j ournalists, filmmakers, businesspeople, and par
ents-to affirm our commitment to the moral and cultural values
that underlie political freedom: honesty, self-reliance, reason, thrift,
education, tolerance, property, contract, and family. Government
can undermine those values, but it cannot instill them.
11
MARKET LIBERALISM
When government taxes savings, we expect to see less thrift.
When government abrogates contracts, we expect people to take
their commitments less seriously. When government takes on the
burden of caring for children and the elderly, we expect families
to become less important. When government subsidizes uneco
nomic or environmentally destructive activities (building luxury
condos on delicate barrier islands, for example), we expect more
waste and environmental destruction. And only a truly crazy set
of policies, as David Boaz points out, could induce millions of
teenage girls to have children without any husbands in sight, tens
of thousands of mothers to walk away from their babies, or hun
dreds of thousands of teenage boys to choose a life of crime. Still,
in each case, while we work to change government policies, we
should expect individual Americans to make responsible choices.
Despite government disincentives, people should save for the
future, live up to their contracts, start families only when they're
prepared for them, and choose honest work over crime. Perhaps
instead of the "Don't help a good boy go bad" ads that were
ubiquitous a few years ago, we should have stuck with the tradi
tional message, "Good boys don't steal cars. "
One of the problems with the aggrandizement of government in
the past generation is that government is no longer capable of
playing its limited but essential role. While it slaps labels on record
albums and teaches us how to have safe sex, government no longer
protects us from violence. Every resident of a major city knows the
futility of calling the police because of a mere automobile break-in,
and in New York City police don't even identify a suspect in half
the murders. Theft costs the American economy something more
than $600 billion a year, much of it in industrial-strength locks,
security guards, and home security systems that we purchase
because government fails to protect us. Just possibly, if government
stopped trying to fix the size of peaches and pick up the tab for
every risk gone bad, it would be able to protect us from violent
crime.
Disillusionment with the Status Quo
Crime, poverty, bad schools, expensive medical care, a faltering
economy-the American people recognize those problems and are
increasingly skeptical of government's ability to solve them. Since
12
Introduction
the 1960s their response has more and more been to tune out
politics. Outside the South (where civil rights enforcement
increased black voting), voter turnout is down 30 percent in three
decades. In 1992 a heated three-way race featuring the country's
leading anti-politician attracted a larger turnout, but it remains to
be seen whether that increase will last. The long-term trend of
declining turnout might indicate that the real mandate of the Ameri
can people is for "none of the above" to run our lives. Young
people between 18 and 24 voted at a rate of only 29 percent in 1988
and only 16 percent in the midterm elections of 1986 and 1990.
According to elections analyst Curtis Gans, "Polling data shows
that those who don't vote and are middle-aged or older tend to be
angry and alienated by the conduct of politics while those who are
younger tend to be indifferent to it. " Gans points out that four
presidential elections in a row "were won by leaders who cam
paigned against the concept of government. " Yet the continuing
failure of government "raises the question of whether government
is capable of anticipating complex societal problems, whether it is
responsive to basic citizen needs and whether the citizen's vote
makes any difference. " Gans concludes, "Who are the sane ones?
Those who still troop loyally to the ballot box . . . ? Or, those who
in increasing numbers eschew the system in protest?"S
Another loyal supporter of the political system, Theodore J. Lowi
of Cornell University, writes, "One of the best-kept secrets in Amer
ican politics is that the two-party system has long been brain dead
kept alive by support systems like state electoral laws that protect
the established parties from rivals and by Federal subsidies and
so-called campaign reform. The two-party system would collapse
in an instant if the tubes were pulled and the IV's were cut.
,,
9 The
strong support for Ross Perot's outsider campaign is testimony to
how Americans feel about the Democrats and the Republicans.
Gans argues, "None of the problems that have pushed voter
turnout downward are insoluble. " We beg to differ. Citizens
increasingly recognize not just that politicians are indebted to spe
cial interests and will do anything to be reelected but that politics
8Curtis Cans, "Turnout Tribulations," Journal of State Government, January-March
1992, Q. 13.
9heodore J . Lowi, "The Party Crasher," Ne York Times Magazine, August 23,
1992, Q. 28.
13
MARKET LIBERALISM
and government are becoming irrelevant to society's real needs. In
our complex world, governments cause far more problems than
they will ever solve; in fact, governments themselves cause most
of the social problems they are then called on to solve. Since our
experience with Jimmy Carter, Ronald Reagan, and George Bush
teaches us that anti-government presidents don't really get govern
ment out of our lives, the next best thing is to try to ignore govern
ment and make the best lives possible for ourselves and our fami
lies. Thus we see a decline in voting and an increase in tax avoidance
and evasion; private school attendance and even home schooling;
private mail and other communications services; private police,
security services, and courts; personal saving for retirement; and
so on. Some of those developments reflect the lingering anti-estab
lishment attitudes of the 1960s. The IRS, for instance, in a study
of tax evasion, found that affluent young people have "a relatively
high values-based predisposition to noncompliant behavior" -in
other words, they don't like being told what to do. 10 Those citizens
will not come back to the polls in response to charisma or vague
calls for change. Only a real crisis in the functioning of society, or
a candidate offering dramatic, believable changes, is likely to make
a sustained difference in turnout rates.
The United States is not the only place where citizens are becom
ing disillusioned with political elites. When Canada's provincial
governors and major parties submitted major constitutional amend
ments to a referendum, the voters delivered "a sweeping repudia
tion of all the country's national leadership, " in the words of the
Washington Post. Elites in Brussels drew up a treaty for a much
more centralized European Community and presented it to the
world as a fait accompli, the next step on the road to social progress
and global community. The first voters to get a crack at it, in tiny
Denmark, turned thumbs down on the idea. Under the European
Community's rules, that ended the discussion because the treaty
had to be aopted unanimously. But Europe's elites wouldn't take
no for an answer; the Danish people may be given a chance to
come to their senses in another referendum.
IO"Tax Cheats Most Likely to Be Yuppies," (Madison, Wis.) Capital Times, August
16, 1985, Q. 9.
14
Introduction
The magnitude of the changes in the world and the irrelevance
of politics have escaped most current political figures, especially
in the United States, who continue to offer programs from a bygone
era. Since the end of the feeting Reagan Revolution, about the
middle of 1981, conservatives have been floundering. Unwilling to
admit that their decade in the White House has left the federal
government bigger and more voracious than ever, they offer mar
ginal changes-a capital gains tax cut, enterprise zones, and the
like. In The Conscience of a Conservative, Barry Goldwater railed
against a $100 billion federal budget and the Departments of Com
merce and Labor. In 1980 Ronald Reagan promised to abolish the
Departments of Energy and Education. A dozen years of Republi
can presidents saw no cabinet departments eliminated and one cre
ated, while federal spending rose from $678 billion to $1. 5 tl on.
Meanwhile, other conservatives have decided that the real issue
is not big government's impact on individual freedom but the need
to use big government to impose conservative values on society.
That approach seemed to peak at the Republican National Conven
tion, where the Republicans gave evidence of relying on Henry
Adams's advice: "Politics, as a practice, whatever its professions,
has always been the systematic organization of hatreds. "
Adams's insight has found a hearing on' the other side of the
political spectrum as well, with some Democrats deciding that
"wealthy bankers, " "people in elegant estates," and especially the
nefarious Japanese would make fine political scapegoats. Rather
than have America compete to be the best in a global economy,
those politicians would blame the Japanese for their success,
describe the sale of high-quality products to voluntary purchasers
as "an economic Pearl Harbor," and build a wall of protection
around uncompetitive industries.
Meanwhile, if the collapse of socialism has deprived the conserva
tives of an enemy, it has deprived anti-capitalist leftists of a theoreti
cal argument for ever bigger government. Some have found their
new j ustification in environmentalism. There are real environmen
tal problems in the United States and the world, as Fred Smith
and Kent Jeffreys argue in chapter 23, but some self-proclaimed
"Greens" seem to view environmental problems primarily as a
pretext for more state control of the economy. Socialist economist
Robert Heilbroner, for instance, spent 50 years insisting that social
ism works; finally, when Gorbachev threw in the towel, so did
15
MARKET LIBERLISM
Heilbroner. In two striking articles, he wrote, "Less than seventy
five years after it officially began, the contest between capitalism
and socialism is over: capitalism has won . . . . Capitalism organizes
the material affairs of humankind more satisfactorily than social
ism. " And again, "It turns out, of course, that Mises was right"
about the impossibility of socialism. 1 1 He then proceeded immedi
ately to insist that we will have to turn to socialism anyway because
of our "ecologically imperilled society"-once again ignoring the
empirical evidence of socialism's record.
As the world moves into the 21st century, rightwingers and
leftwingers will continue to fight the battles of the 1950s. One
valiant attempt to move beyond those retrograde positions has
been made by David Osborne and Ted Gaebler in their important
book Reinventing Government: How the Entrepreneurial Spirit Is Trans
forming the Public Sector. Osborne and Gaebler recognize that "the
kinds of governments that developed during the industrial era,
with their sluggish centralized bureaucracies, their preoccupation
with rules and regulations, and their hierarchical chains of com
mand, no longer work very well. " Their arguments are refected
in Bill Clinton's call for a "revolution in government . . . to shift
from top-down bureaucracy to entrepreneurial government that
empowers citizens and communities. " Osborne and Gaebler know
all the things government should become: catalytic, community
owned, competitive, mission driven, results oriented, customer
driven, enterprising, anticipatory, decentralized, and market ori
ented. But we believe they dramatically underestimate the diffculty
of getting coercive institutions to exhibit those characteristics.
Osborne and Gaebler have done a heroic job of finding examples
of government agencies that operate the right way: competitive
service provision in Phoenix, results-oriented public housing in
Louisville, an enterprising Olympics in Los Angeles. But every
institution in the private sector of society operates according to
those 10 attributes every minute of every day. Instead of undertak
ing the Herculean if not Sisyphean task of trying to get government
agencies to be customer driven, market oriented, and so on,
wouldn't it be better simply to rely on the voluntary sector for more
llRobert Heilbroner, "The Triumph of Capitalism," Ne Yorker, January 23, 1989;
Robert Heilbroner, "After Communism," Ne Yorker, September 10, 190.
16
Introduction
of our needs? Osborne and Gaebler have set the right goals for
21st-century government; it only remains to discuss how we might
best achieve them.
A Paradigm for the 21st Century
Market liberals offer an expansive, inclusive vision for society.
We look forward to seeing men and women, in the words of the
Nation in 1900, freed from the vexatious meddling of governments,
once again able to devote themselves to their natural task, the
bettering of their condition. Wherever we look in society, as the
essays in this volume illustrate, we find social problems created by
clumsy government intrusion into private relationships.
An unconstrained vision for society-a vision that sees women
and men building a free, prosperous, and pluralistic society in
every corner of the globe-requires a constrained vision of govern
ment. We need to restore in this country the Founders' understand
ing of government: a necessary evil, created for the sole purpose
of securing our rights, with a few clearly specified powers. As
Jefferson put it in his first inaugural address, "A wise and frugal
government, which shall restrain men from injuring one another,
which shall leave them otherwise free to regulate their own pursuits
of industry and improvement, and shall not take from the mouth of
labor the bread it has earned. This is the sum of good government."
Tha t message-the l iberation of individual creativity by the
restraint of government power-is also needed i n the rest of the
world, especially in such places as China, Africa, and the Arab
world, where people still suffer under brutally repressive govern
ments. Fortunately, it appears that the world is slowly, grudgingly
moving in that direction, as the benefits of liberal society become
more apparent.
In his history of the 20th century, Modern Times, Paul Johnson
wrote:
Disillusionment with socialism and other forms of collectiv
ism was only one aspect of a much wider loss of faith in
the state as an agency of benevolence. The state was the
great gainer of the twentieth century; and the central
failure . . . . Whereas, at the time of the Versailles Treaty,
most intelligent people believed that an enlarged state could
increase the sum total of human happiness, by the 1980s
the view was held by no one outside a small, diminishing
17
MARKET LIBERALISM
and dispirited band of zealots. The experiment had been
tried in innumerable ways; and it had failed in nearly all of
them. The state had proved itself an insatiable spender, an
unrivalled waster. Indeed, in the twentieth century it had
also proved itself the great killer of all time . . . .
What was not clear was whether the fall from grace of
the state would likewise discredit its agents, the activist
politicians, whose phenomenal rise in numbers and author
ity was the most important human development of modern
times. As we have noted, by the turn of the century politics
was replacing religion as the chief form of zealotry. To arche
types of the new class . . . politics-by which they meant
the engineering of society for lofty purposes-was the one
legitimate form of moral activity, the only sure means of
improving humanity . . . . At the democratic end of the spec
trum, the political zealot offered New Deals, Great Societies
and Welfare States; at the totalitarian end, cultural revolu
tions; always and everywhere, Plans . . . . By the 1980s, the
new ruling class was still, by and large, in charge; but no
longer so confident. . . . Was it possible to hope that the
"age of politics," like the "age of religion" before it, was
now drawing to a close?12
By the end of the 1980s, confidence in politics and government had
declined still further, and John Naisbitt and Patricia Aburdene could
write in Megatrends 2000 that "the great unifying theme at the end
of the 20th century is the triumph of the individual. "
As we approach the 21st century, there i s a growing recognition
by thinking people throughout the world that the old paradigm of
structuring societal arrangements coercively through governmental
mechanisms is crumbling. It is in the nature of human beings to
be free, and increasingly we are coming to realize that freedom
from bureaucratic institutions-in government and in the private
sector-not only is consistent with human nature but is the source
of human progress. Market liberalism provides a framework for a
dynamic, pluralistic society that can yield a future of undreamed
of prosperity and human fulfillment. It seems to us that the time
to unleash its potential is at hand.
12Paul Johnson, Modern Times: The World from the Twenties to the Eighties (New
York: Harper & Row_ 1983), pp. 729-30.
18
ART
FMPERlCAMNlSlOM
Z. Freedom, Responsibility, and the
Constitution: On Recovering Our
Founding Principles
Ro
g
er Pilon
The quadrennial elections that give rise to volumes such as this
afford an opportunity not simply to take stock and look ahead but
to ask more searching questions having to do with what we stand
for as a nation. After the monumental changes that have taken
place around the world over the past four years, such questions
would seem especially fitting. Yet the national debate during our
recent elections hardly touched those deeper issues. Driven not by
principle but by policy, not by visions of who we are but by visions
of what we want, we seem near century's end to be stuck in the
rut of the welfare state, part free, part controlled, unable to see
beyond our immediate concerns. Nor should that surprise, since
the mundane interests the welfare state has brought into opposition
compel us to that war of all against all that the classical theorists
so well understood. And we are all the poorer for it.
Indeed, our political life today is dominated by the view, held
by politicians and citizens alike, that the purpose of government
is to solve our private problems, from unemployment to health
care, retirement security, economic competition, child care, educa
tion, and on and on. But having thus socialized our problems, our
fight from individual responsibility does not end. For once we
realize, however dimly, that social benefits require social costs
either taxes or regulations-we then seek to foist those costs upon
the wealthy or the industrious. Yet that move has its limits-the
rich and industrious can afford to leave, after all. So we try next
to shift the costs of our appetites to our children in the form of the
federal deficit. Tax and spend thus becomes borrow and spend as
the flight from responsibility, and reality, continues.
21
MARKET LIBERALISM
To some extent, of course, the idea that the purpose of govern
ment is to solve the private problems of living has always been with
us, but never have political and cultural conditions so encouraged it.
In fact, recognizing that there would always be those who would
be willing to relinquish responsibility for their lives to government
authorities and institutions, and realizing the implications should
that attitude ever command political respect, the founding genera
tion tried to guard against that possibility by drafting a constitution
for limited government. Over the years, however, the restraints set
forth in that document have broken down, and with that break
down has come the gradual demise of individual liberty and respon
sibility. If that trend is to be reversed, if we are to realize the
potential that our founding principles permit, it is essential that
we understand the forces that have been at work, the forces that
have brought us from the vision of the founding generation to our
current state of political conflict and paralysis.
The Original Design: From the Declaration to the Civil War
Amendments
We are fortunate in America to have a philosophy, set forth in
a series of documents, to which to repair to renew our first princi
ples. That philosophy, stated succinctly in the Declaration of Inde
pendence, then more amply in the Constitution, the Bill of Rights,
and the Civil War Amendments, can be seen as composed of two
parts. First is the moral vision, the world of moral rights and obliga
tions we all have prior to the creation of government, which we
create government to secure. Second is the political and legal vision,
the world of political and legal powers we authorize when we create
government, which serve as the means of securing the moral vision.
Nowhere is that divide between the moral and the political more
clearly seen than in the Declaration, whose seminal phrases have
inspired countless millions around the world for more than two
centuries. After placing us squarely in the natural law tradition
the "truths" that followed were held to be "self-evident," or truths
of reason-the Founders set forth a premise of moral equality,
which they defined with reference to our natural rights to life,
liberty, and the pursuit of happiness. Only then did they turn to
the second, the political or instrumental point-that to secure those
rights, governments are instituted among men. And even then
22
Our Founding Principles
they added a moral qualification-that to be just, government's
powers must be grounded in consent-making it clear that political
power, to be legitimate, must be derived from moral principle.
Thus, the moral vision must be drawn first, the political and legal
vision second, as a derivation from the former.
The Moral Vision
As just noted, the moral vision begins in the natural law tradition,
with the individual, not with the group, and with the moral equality
of all individuals, defined by our equal rights to life, liberty, and
the pursuit of happiness. The importance of that starting point
cannot be overstated. By placing us in the natural law tradition,
the Founders were saying that there is a higher law of right and
wrong, grounded in and discoverable by reason, against which to
judge positive law, and from which to derive positive law. Without
such a compass, positive law is mere will, the expression of the
will of those in power. And mere will, whether of the king or of
the majority, does not give law its legitimacy. Only principles of
reason can do that.
Moral Rights. In that higher law tradition, then, we proceed from
a premise of moral equality-defined by rights, not values-which
means that no one has rights superior to those of anyone else. So
far-reaching is that premise as to enable us to derive from it the
whole of the world of rights. Call it freedom, call it live-and-Iet
live, call it, in the socialist planning context, the right to plan and
live our own lives, the premise contains its own warrant and its
own limitations. It implies the right to pursue whatever values we
wish-provided only that in doing so we respect the same right
of others. And it implies that we alone are responsible for ourselves,
for making as much or as little of our lives as we wish and can.
What else could it mean to be free?
The connection here between freedom and responsibility is espe
cially important to notice. As the discussion throughout the found
ing period makes clear, freedom and responsibility were joined in
the liberal mind in a thoroughly modern way. It was not, as an
older way of looking at things had it (and as contemporary " commu
nitarians" often imply), that we enjoy our rights as grants or "privi
leges," which we retain only as long as we exercise them "responsi
bly. " No, we have our rights "by nature. " Thus, we alone can
23
MARKET LIBERALISM
alienate them-through contract, for example, or by committing
torts or crimes. The mere "irresponsible" exercise of rights, short
of violating the rights of others, is itself a right. What else could it
mean to be responsible for oneself?
The discussion during the founding period also makes it clear
that two rights serve as the foundation for all others-property
and contract. Indeed, John Locke, whose thinking found its way to
the heart of the Declaration, reduced all rights to property: "Lives,
Liberties and Estates, which I call by the general Name, Propert
y
."
It should hardly surprise, upon refection, that Locke and the Amer
ican Founders would think that way. After all, to have rights to
life, liberty, and the pursuit of happiness is to be "entitled" to those
things, to hold "title" to them, and to be able to "claim" that others
may not "take" them from us. As the very language of rights
indicates, rights and property are inextricably connected: our prop
erty in our "lives, liberties, and estates" is what rights are all about.
Thus, we discover what our natural rights are by spelling out the
many forms the property we possess in ourselves and in the world
can take, from life to liberty of action to freedom from trespass
upon our person or property. Included among our natural rights,
then, are both liberties (of action) and immunities (from the torts
or crimes of others), both of which have property as their founda
tion. In general, whether in the area of expression or religion or
commercial activity or privacy or whatever, we are free to enjoy
what is ours except insofar as doing so prevents others from enjoy
ing what is theirs.
Broadly understood, then, property is the foundation of all our
natural rights. Exercising those rights, consistent with the rights
of others, we may pursue happiness in any way we wish. One
way to do that, of course, is through association with others. We
core then to the second great font of rights, promise or contract.
(The rights we create through contract are not natural rights-we
do not have them "by nature" -but like natural rights they are a
species of moral right.) Through voluntary agreements with others
we create the complex web of associations that constitutes the better
part of what we call civilization. Here, the rights and obligations
created are as various as human imagination allows, whether they
arise from spot transactions or from enduring agreements creating
institutions ranging from families to churches, clubs, corporations,
charitable organizations, and much else.
24
Our Founding Principles
Legal Recognition. In outline, then, this is the moral world
described by our moral rights and obligations, both natural and
contractual-that we created government to secure. In fact, when
we look to the Constitution, the Bill of Rights, and the Civil War
Amendments, we find explicit recognition of those rights. The Fifth
Amendment's takings clause recognizes the right to private prop
erty, for example, as the Constitution itself recognizes the right to
contract. In the Fifth and Fourteenth Amendments we find that no
one may be deprived of life, liberty, or property without due process
of law. (And by "law" the drafters could hardly have meant mere
legislation or the guarantee would have been all but empty.) Simi
larly, the Thirteenth Amendment abolished at last the practice of
slavery or involuntary servitude, making it plain that no one may
own another, that each of us owns himself and himself alone.
The privileges and immunities clauses of both the Constitution
and the Fourteenth Amendment hark back to our "natural liber
ties," as William Blackstone made clear in his Commentaries on the
Laws of England. Likewise, the Seventh Amendment's reference to
and, by implication, incorporation of the common law reminds us
of Edward Corwin's observation, in The "Higher Law" Background
of American Constitutional Law, that "the notion that the common
law embodied right reason furnished from the fourteenth century
its chief claim to be regarded as higher law." The First Amend
ment's guarantees regarding religion, speech, the press, assembly,
and petition; the Second Amendment's recognition of the right to
keep and bear arms; the several guarantees in the Constitution and
the Bill of Rights regarding criminal investigations and prosecu
tions; and finally the Ninth Amendment's reminder that only cer
tain of our rights are enumerated in the Constitution, the rest
remaining unenumerated and retained, are among the many indica
tions, ranging over nearly 100 years, of the kind of world earlier
generations had in mind for government to secure.
That world, the moral vision the Founders first set forth, was
one of private individuals standing in private relationships with
one another, each with a right to make of himself as much as he
wished and could, and each responsible for his choices and actions,
good and bad alike. It was a world both static and dynamic. The
minimal legal framework, designed to secure our rights and obliga
tions, was static in the sense that it was derived from immutable
25
MARKET LIBERALISM
principles of right and wrong, reflecting the human condition as
such. Yet the Founders' world was fundamentally dynamic in that
it allowed for-indeed, protected-the rich variety of human expe
rience and experiment that we all know is possible under conditions
of freedom. That dynamism was expected to come from individuals,
however, not from government. In particular, it was not govern
ment's responsibility to promote prosperity. Rather, that was the
business of individuals, alone or in private association with each
other.
It is especially important to notice too that the world the Founders
envisioned was largely a world of private law, which enabled peo
ple to prosper or fail, protecting them only from the depredations
of others. It was not a world of public law, especially public redis
tributive law, which could only encourage people to look to govern
ment both for prosperity and for protection from failure. No, the
purpose of government, as the Constitution states, is to promote the
general welfare-that is, the welfare of all-by establishing justice,
ensuring domestic tranquility, and securing the blessings of liberty.
If government limited itself to those ends, individuals would be
free, in their private capacities, to pursue their own welfare, for
which they alone are responsi bl e.
The Political and Legal Vision
To secure that moral vision, a vision of individual liberty and
individual responsibility, governments were created and govern
ment powers were authorized. Here, two closely related problems
arose, one moral, the other practical.
The Limits of Consent Theory. The moral problem, which had its
practical aspect, stemmed from the Declaration's consent require
ment (captured with respect to the states in the Constitution's
ratification clause) that to be just or legitimate, power had to be
derived from the consent of the governed. Plainly, if we begin with
the right of the individual to be free and hence to rule himself,
and himself alone, the consent requirement is necessary, for the
individual may be bound by the will of others only if he has agreed
to be bound. The difficulty in meeting that requirement, however,
is substantial. To begin, although unanimity does produce legiti
macy, it is all but impossible to achieve. But when we resort to rule
by the majority, even by a large majority, we do not get legitimacy
26
Our Founding Principles
because the minority, by definition, has not consented. Yet there
are problems even when we combine majoritarianism with prior
unanimous consent to be bound thereafter by the majority-the
classic social contract approach: the people who agreed to the origi
nal contract were few in number; even then we would still need
unanimity; and the problem of binding subsequent generations,
which subsequent elections do not really solve, remains. Finally,
the argument from "tacit consent"-those who stay are bound by
the will of the majority-has the majority putting the minority to
a choice between coming under its will or leaving, which begs the
very question that needs to be answered.
Those moral diffculties leave us with a pair of conclusions that
were more or less understood by the founding generation. First,
even democratic government has about it the character of a "neces
sary evil. " Government is "necessary" to overcome the practical
problems that surround the private enforcement of rights in its
absence, problems that Locke and others had catalogued. But it is
"evil" insofar as the consent requirement cannot be deeply satis
fied. Thus, while majoritarian democracy may be preferable to other
forms of rule in that it enables the ruled to participate in the deci
sionmaking process, in the end it is simply a process through which
to decide, not a process that imparts legitimacy to the decisions
that follow-as those in the minority are often the first to attest.
The second conclusion, or prescription, that follows from refec
tion on the moral difficulties that surround the creation of govern
ment stems from the realization that government, unlike a private
organization, is a forced association. Given that character, it
behooves us to do as little as possible through government and as
much as possible in the private sector, the better to minimize the
use of force. Thus, out of respect for the nature of government, at
least, the founding generation sought to limit the power of this
necessary evil, giving it only as much as would be necessary to
accomplish its ends.
Limiting Power. Given those moral insights, the practical problem
the Founders faced was to create a government that was at once
strong enough to secure our rights yet not so strong as to violate
those very rights in the process. Thus, they created a set of limited
powers; but realizing that power tends to corrupt, they checked
27
MARKET LIBERALISM
and balanced those powers at every turn. One such check, of
course, was the electoral process. Yet that process was itself checked
by everything from representative government to the indirect elec
tion of senators and presidents to the lifetime appointment of
judges. At the same time, power was divided between the federal
and the state governments, with most reserved to the states, where
presumably it could be more immediately controlled by the people.
Meanwhile, at the federal level, power was separated among the
three branches, each of which had checks upon the others. The
final check was the power of the j udiciary to review the acts of the
political branches and the states and rule them unconstitutional .
But the most important restraint, especially given the power of
j udicial review, was meant to be found in the central strategy of the
Constitution, which made it clear that ours was to be an extremely
limited government. First, the Constitution was a document of
enumerated powers, meaning that the federal government was to
have only those powers that were strictly enumerated in the text.
Second, the exercise of those powers was to be restrained by the
necessary and proper clause, which authorized Congress to exercise
its limited powers only through laws that were necessary and
proper for doing so. And finally, a bill of rights was added to the
Constitution, which together with the guarantees in the original
document itself made it plain that the federal government was to
be further restrained in the exercise of its enumerated powers by
both enumerated and unenumerated rights.
Thus, while the federal government was given enough power
to govern, the Founders' idea of governing was extremely limited,
especially when contrasted with the governing done by European
governments at the time and our own government today. Indeed,
given the limits the Founders placed on government, it is difficult
to understand how anyone could argue that the Constitution au
thorizes the kind of expansive government we have today. In fact,
honest observers who are at the same time friends of the modern
welfare state readily admit that to get to where we are we had to
turn the document on its head. Others may wish to defend our
present arrangements as constitutional. The concern here will be
more constructive-to trace some of the forces that led to the break
down of constitutional restraints on the growth of government, the
better to understand what must be done to recover those restraints
and the principles they secured.
28
Our Founding Principles
The Demise of Principle, the Rise of Policy
In 1948 Richard M. Weaver wrote a book entitled Ideas Have
Consequences, the title and text of which captured welJ the power
of ideas in human history. In contrast, Karl Marx had pointed a
century earlier to the importance of material forces. Marx was right
to remind us of that, but as his own infuence bears witness, he
underestimated the far greater power of ideas-sound and
unsound ideas alike. Indeed, the ultimate defeat of the Marxist
vision is a tribute to the force of superior ideas, which triumphed
in the face of brute material and military force.
Still, we do not have a clear picture, nor is it likely that we ever
will, of just how ideas and events interact over time-whether it
is by their intrinsic force that ideas prevail, or fail to prevail, or by
the consequences that eventually result from adhering to one set
of ideas rather than another, or by some combination of the two.
We have an intuitive understanding, to be sure, that "the climate
of ideas" matters. But just how it matters is, well, another matter
and rather less than a science.
The "Science" of Policy
The rise of science, however, has had more than a little to do
with the demise of the Founders' vision, which is all the more
ironic since those men, products all of the Age of Reason and the
Enlightenment, were steeped in the science of their day and hardly
of the view that later "science" might undermine their creation.
Their science, however, had a healthier sense of its limits and of
the balance between the rational and the empirical than later science
would have. Indeed, the Founders' science of man, although but
tressed by empirical observation, was essentially a rational under
taking in its normative aspects. Yet in time that moral vision
uncertainly grounded in reason, to be sure-would core under
attack not simply from the skepticism that has been with us since
antiquity but from skepticism armed with a new science of man.
Reductionist (both theoretical and material) and empirical, this
newer science would take as its task not the rational justification
of principles of right and wrong but the empirical explanation of
human behavior. Once we understood the forces of nature or nur
ture that made us behave as we did, the next step, of course,
would be to devise social institutions to encourage desirable and
29
MARKET LIBERALISM
discourage undesirable behavior. Could social planning-indeed,
social engineering-be far off?
From Natural Lw to Utilitarianism. But first, a frontal attack on
natural law would prepare the way. Although not well appreciated
until the German philosopher Immanuel Kant took note of it later
in the century, the Scottish philosopher David Hume delivered
perhaps the most telling blow to natural law in 1739 when he
observed, almost in passing, that from descriptive propositions one
could not derive normative conclusions, a shot that went to the
heart of the relatively primitive epistemology of the natural law
theorists. More direct and conclusory in his attack was Jeremy
Bentham, the father of British utilitarianism, who in 1791 intoned
that talk of natural rights was "simple nonsense: natural and impre
scriptible rights, rhetorical nonsense,-nonsense upon stilts. " Such
attacks were not the stuff of the daily press, of course. Nevertheless,
they slowly seeped into the climate of ideas, undermining in time
the almost credulous faith that underpinned the Founders' vision
and the institutions they created to secure it.
The central theme in the eventual breakdown of our structure
of restraints, then, is the demise of the moral foundations of that
structure and the rise of new rationales for political power. And
what were those new rationales? As already noted, there was a
growing faith during the 19th century and into the 20th in the
ability of science to solve social problems. That faith was buttressed
by the rise of utilitarianism in moral theory, which looked not
backward to principles of right and wrong but forward to conditions
of good and evil, reduced to intersubjectively verifiable and hence
to empirically quantifiable reports of pleasure and pain. Policy and
law came to be justified, in this approach, not by whether they
secured rights but by whether they produced the greatest good for
the greatest number. Respect for property and contract might yield
that result. Then again it might not, depending on the circum
stances. Policy, including legal policy, would have to adjust to
changing circumstances and to the emerging theories of the new
policy science.
Progress. Material changes were taking place as well, of course.
The 19th century saw the dawn of the Industrial Revolution in
America and with it the growth of urbanization. Poverty, endless
30
Our Founding Principles
work, child labor, and unhealthy living conditions had been tolera
ble, presumably, when dispersed throughout rural America. When
concentrated in urban America, and when contrasted with the con
ditions of the emerging entrepreneurial class, they became "social"
problems. Naturally, such problems played directly into, and recip
rocally with, the themes of the emerging social sciences. At centu
ry' s end, in fact, the Encyclopedia of Social Reform could state with
confidence that "almost all social thinkers are now agreed that the
social evils of the day arise in large part from social wrongs. "
Remedying such "wrongs" was clearly beyond the scope of private
charity, administered by individuals who "suffered with" their
recipients, making moral distinctions in the process. What was
needed, rather, was public charity, administered by "professional"
social workers, for "no person who is interested in social progress
can long be content to raise here and there an individual," wrote
Frank Dekker Watson, director of the Pennsylvania School for Social
Service. Indeed, in The Charity Organization Movement in the United
States, published in 1922, Watson commended the ongoing "crowd
ing out" of private by public charity, for only thus would "public
funds ever be wholly adequate for the legitimate demands made
upon them. "
Democracy and Good Government. Over the course of the 19th cen
tury, then, the climate of i deas gradually changed. In ethics, we
moved from natural law to utilitarianism. In science, we moved
from a conception of man as an autonomous being to one of man
as determined by natur.al and environmental forces. Still, in a consti
tutional regime like ours, social workers armed with such theories
and acting as "social engineers" could not simply impose "a divine
order on earth as it is in heaven," as Owen Lovejoy, president of
the National Conference of Social Work, envisioned in a 1920 article.
Rather, in a government "of, by, and for the people," that new
order would have to come in some way, at least, from the people.
Thus conceived, however, democracy would prove no restraint.
On the contrary, ignoring its individualist roots in selfrule, imbued
with the collectivist overtones of "the people," and treated opera
tionally as majoritarianism, democratic theory dovetailed quite
nicely with the new policy science. After all, if policy and law were
j ustified not with respect to rights but only insofar as they promoted
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the greatest good for the greatest number, and if we could deter
mine that they do that only empirically, then how better to do the
utilitarian calculus than through the majoritarian process? By their
votes the people will tell us which policies maximize their well
being.
Thus, by the Progressive Era, toward century's end, we had
come to think of government not as a necessary evil, to be guarded
against at every turn, but as a positive good-indeed, as an instru
ment of good, an instrument for doing good. Combining the force
of law, viewed instrumentally, with the ambition of the new social
sciences and the rationales of both utilitarianism and majoritarian
ism, government had come to be seen as an institution through
which to solve our social problems. Plainly, that was a fundamental
shift in our thinking. That shift, moreover, was not limited to social
problems narrowly understood or to the political branches. When
the common law courts began shifting in the middle of the 19th
century from strict liability to a negligence standard in torts-to
make the world safe for industry-and Congress in 1890 saw fit to
pass the Sherman Antitrust Act-to restore effective competition
to the market economy-those and countless other such measures
were indications all of that fundamental shift: from government
instituted to secure principle to government empowered to pursue
policy. Just whose policy, and by what constitutional means, were
questions that remained to be answered.
Instituting the Shift
It is one thing to have a shift in ideas-from a conception of
limited government, instituted to secure rights, to a conception of
expansive government, empowered to pursue policy-quite
another to incorporate that shift through and in institutions that
were designed precisely to restrain such a change. How, in short,
can a limited government be turned into an expansive government
when the constitution that authorizes the former not only contains
no provision for the latter-save by amendment-but, to the con
trary, contains provisions that explicitly restrict the creation of the
latter?
For more than 200 years-albeit less frequently as the restraints
have broken down-that question has confronted every person and
every movement that has sought to expand the federal government.
32
Our Founding Principles
And for nearly three-quarters of that time, up until the New Deal,
the constitutional restraints did largely hold. But as noted above,
inroads on the original design were being made all along. The
change in the climate of ideas was gradually taking its toll, first on
the most political branch of government, the Congress, then on
the second of the political branches, the executive, and finally on
the branch that in principle is nonpolitical, the judiciary.
It is important to stress, however, how slow that change was in
coming. Today, it seems almost quaint to recall that, for the better
part of the 19th century, Congress actually debated about whether
it had constitutional authority to do what some of its members
wanted from time to time to do. And when Congress did act along
lines of dubious authority, presidents often vetoed those acts as
unconstitutional . Finally, those measures that did make it through
both of the political branches had to withstand Supreme Court
scrutiny, which was by no means assured. In short, unlike today,
when the political branches all but assume their authority to expand
government, which the courts have acquiesced in and now restrain
only in limited domains (and sometimes themselves affirmatively
assist), earlier officials in all branches took seriously their oaths to
support the Constitution.
In the Political Branches. In the 19th century, in fact, the constitu
tional debate often never reached the rights side of the question
the side that dominates modern discussions-because the focus
was largely on whether Congress (or the executive) had the power
to undertake a given activity. An early example was a 1 794 statute
appropriating $15, 000 for relief of French refugees who had fled
to Baltimore and Philadelphia from a Negro insurrection in San
Domingo. As the principal author of the Constitution, Virginia's
James Madison remarked that he could not "undertake to lay his
finger on that article of the Federal Constitution which granted a
right to Congress of expending on objects of benevolence the money
of their constituents. " In fact, so dubious was the authority for this
act of charity that it was rewritten, still dubiously, to be part pay
ment of loans earlier obtained from the French Republic. Two years
later, in 1 796, a similar bill, for relief of Savannah fire victims, was
defeated decisively, a majority in Congress finding that the general
welfare clause afforded no authority for so particular an appropria
tion. As Virginia's William B. Giles observed, "The House should
33
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not attend to what generosity and humanity required but what the
Constitution and their duty required. "
The 19th century saw growing pressure on Congress t o engage
in a wide range of "general welfare" spending, the constitutional
ramifications of which have been well documented in Charles War
ren's Congress as Santa Claus, written on the eve of the New Deal.
Almost as intense, however, was the opposition, from constitu
tional principle, to having such projects undertaken or even funded
by the federal government. Thus, in 1817 President Madison vetoed
a bill authorizing Congress not to undertake a public works project
for there was clearly no enumerated power to that end in the
Constitution-but simply to appropriate money for that purpose
under the general welfare clause. Madison could find not even this
limited a power, for as he had earlier written, "Money cannot be
applied to the General Welfare, otherwise than by an application
of it to some particular measure conducive to the General Welfare, "
and that particular measure must be "within the enumerated
authority vested in Congress. "
Nevertheless, the view that Alexander Hamilton had advanced,
that Congress had a general welfare power to fund at least
"national" projects, eventually triumphed when President Monroe
endorsed i t in 1 822 as part of a veto message. Still, efforts to have
the federal government take the next step and actually conduct
such projects were resisted by Presidents Jackson and Van Buren.
Indeed, throughout the 19th century we find presidents ranging
from Tyler, Polk, Pierce, and Buchanan, before the Civil War, to
Grant, Arthur, and Cleveland, after the war, standing athwart such
efforts by Congress to expand its powers. Nor should it be thought
that their vetoes were merely "political" and not principled. In 1854,
for example, President Pierce was faced with a bill, championed by
a luminary of the day, Dorothea Dix, that would have given as a
gift to the states 10 million acres of federal lands for the benefit of
the indigent insane. Faced with a distinction between donating
land and donating general tax revenues (which would be the next
target of public avarice) , and with such congressional pleas as "Our
forefathers left the hands of the Government unfettered to spend
what it might choose for their benefit," Pierce stood his ground on
both counts-and on principle as well .
34
I cannot find any authorty in the Constitution for making
the Federal Government the great almoner of public charity
Our Founding Principles
throughout the United States. To do so would, in my j udge
ment, be contrary to the letter and the spirit of the Constitu
tion and subversive of the whole theory upon which the
Union of these States is founded.
Thirty-three years and many vetoes later, in 1887, President
Cleveland would take a similar stand against a bill that would
have appropriated $10,000 from general revenues to buy seeds for
distribution to Texas farmers suffering from a drought.
I can find no warrant for such an appropriation i n the Consti
tution, and I do not believe that the power and duty of the
General Government ought to be extended to the relief of
individual suffering which is in no manner properly related
to the public service or benefit. A prevalent tendency to
disregard the limited mission of this power and duty should,
I think, be steadfastly resisted, to the end that the lesson
should be constantly enforced that though the people sup
port the Government, the Government should not support
the people.
It should not be thought, however, that Congress over the course
of the 19th century simply rolled over to special interests, although
that trend was gaining. In fact, throughout the century we see in
Congress not simply the political but the constitutional debate as
well. Thus, as late as 1887 we find Republican Sen. John J. Ingalls
of Kansas decrying a measure to distribute moneys from the Trea
sury to the states to establish agricultural experiment stations.
It illustrates the tendency of this class of agitators to demand
the continual interposition of the National Government in
State and local and domestic affairs, vrith the result, as
I believe, of absolutely destroying the independence and
freedom of individual conduct and subverting the theory
on which the Government is based and in the conduct of
which hitherto it has reached such great results . . . . It is
not desirable that there should be uniformity of methods
and results in the different . . . States. It is the conflict of
the contrariety of opinions in this country upon these sub
jects that results in the greatest good to the greatest number.
It is the collision and contest between opposing ideas or
views of contending localities that enable us to reach the
highest results in the departments of activity and govern
ment.
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MARKET LIBERLISM
Notice how the language of utilitarianism had crept intothe debate.
More generally, notice how Ingalls's rationale, although in part
constitutional, is grounded rather more in policy than in principle.
Not only is "the greatest good to the greatest number" his criterion,
but "great results" and "highest results" are his focus rather more
than the inherent wrong of "continual interposition" in state, local,
and domestic affairs.
As federal "interposition" increased, that shift from principle to
policy would increase as well, not least because principle was being
abandoned. Thus, we find South Dakota Sen. Thomas Sterling
objecting in 1914 that a proposal appropriating $. 5 million annually
for states to give instruction in farm work and home economics
"costs too much, and the nation itself will, in the end, feel the
enervating influence of such a policy. " In the same consequentialist
vein, moreover, there was growing recognition, however faint, that
federal programs were indeed moving us in the direction of the
classic war of all against all. Thus, senators from California and
Connecticut inquired of this bill, perhaps rhetorically, "Why should
we expend the public money for educating the farmers of this
country any more than the mechanics?" As if to meet that challenge
and raise the stakes, Congress three years later appropriated $7
million annually to pay states for the training of teachers in agricul
ture, home economics, industrial subjects, and trade. The answer
to an objection based on unfair consequences, apparently, was not
to return to principle-for there was no longer any principle to
return to-but to expand the program to include some of those left
out. That expansion, of course, never ends.
In the Courts. Thus it went for some 150 years, with discussion
of principle gradually yielding to discussion of policy. But again,
it is important to note how much of the discussion took place in
the political branches. Not that the Supreme Court played no part
at all; rather, its part was smaller than we might imagine today,
largely because things less frequently got to the Court. The ambi
tions of Congress grew only slowly, and were often checked in
that branch. Then when bills did get out of Congress, the executive
branch was there to check them. What part the early Court did
play, especially under Chief Justice Marshall, was largely one of
securing its jurisdiction and ensuring the authority of the federal
36
Our Founding Principles
government over that of the states-although again, in a rather
limited way by today's standards.
At the same time, i t needs to be said that when the 19th-century
Court was presented with claims not simply about powers but
about rights as well, it was not always solicitous of the individual
confronted by an assertion of public power. Just after the Civil War,
for example, the Court considered a challenge brought by a number
of New Orleans butchers to a Louisiana statute chartering a private
slaughterhouse corporation as a monopoly within an l, 150-square
mile area. The complaining butchers claimed that the effect of the
statute was to prevent them from practicing their trade in the district
and hence, among other things, to deny them their privileges and
immunities contrary to the guarantees of the recently passed Four
teenth Amendment: "No state shall make or enforce any law which
shall abridge the privileges or immunities of citizens of the United
States. /I As noted earlier, he debate surrounding the adoption of
the Fourteenth Amendment had made it clear that the right to
pursue one's livelihood unfettered by such interference as the Loui
siana statute interposed was at the core of those privileges and
immunities that Blackstone had located in our "natural liberties. /I
Nevertheless, by a vote of 5 to 4, a sharply divided Court found
for the state, effectively removing the clause from the Constitution.
As a harbinger of the Court's future jurisprudence, however,
one line in the majority opinion in Slaughterhouse stands out: "Such
a construction [as plaintiffs urge] . . . would constitute this court
a perpetual censor upon all legislation of the States, on the civil
rights of their own citizens, with authority to nullify such as it did
not approve as consistent with those rights. /I Indeed, such a role,
at least with respect to the federal government (prior to the Civil
War Amendments), is precisely what Madison had in mind when
he characterized the Court as the "bulwark of our liberties. / I Its job
is to stand astride the political branches, ensuring that their acts
both proceed from authority granted them and are consistent with
rights restraining them, failing either of which those acts must be
found unconstitutional. If the Court cannot or will not be a "perpet
ual censor," it has no business engaging in judicial review because
it has no business existing.
That single sentence, however, speaks volumes about the majori
ty's misunderstanding of the Court's function, a misunderstanding
37
MARKET LIBERALISM
that would emerge full-blown from the New Deal Court. The choice
of the deprecating word "censor," for example, suggests a failure
to appreciate how limited, yet crucial, the Court's power is. To be
sure, it has the power to negate-to give the censor's "no. " But
the power to "nullify" is not the power to "(dis)approve" insofar
as "approve" suggests a power to make value judgments. Rather,
as the sentence continues, it is a power to decide merely whether the
legislation is or is not " consistent" with the civil rights of citizens. To
do that, however, the Court must know what those civil rights are.
And here, the ambiguity of the majority's formulation comes to
the fore. For either the legislation is "on" the civil rights of the
citizens, declaring in positive law just what those rights are, in
which case it could never be inconsistent with "those rights" (unless
the positive law were internally inconsistent) . Or else the legislation
is declaratory of the citizens' rights, but the rights it declares have
some independent basis such that the legislation might " get it wrong"
in its declarations, in which case "those rights" might indeed be
inconsistent with the rights declared by the legislature.
Clearly, it was the latter scenario that the Founders, and the
authors of the Fourteenth Amendment, had in mind when they
derived our positive law from higher law-and especially when
they spoke in the Ninth Amendment of retained rights. Subsequent
legislators (or even courts) might get it wrong when they set about
declaring the law: they might declare that a right existed when in
fact, by higher law standards, it did not; or they might authorize
a power, as here, the effect of which was to extinguish a right that,
by higher law standards, did exist. To determine those kinds of
questions, however, the Court would have to know and understand
the higher law. And that, precisely, is what the Slaughterhouse
majority refused to undertake, despite the impassioned yet rea
soned example of the minority, arguing from "the natural and
inalienable rights which belong to all citizens. "
During the early years of the Republic, courts had not been nearly
as reluctant as the Slaughterhouse majority was to proceed from first
principles. Writing in the University of Chicago Lw Review in 1987,
Suzanna Sherry documented a number of cases during the first 30
years of the nation in which we find courts turning to both written
and higher law to reach their decisions. After that, however, the
decline of natural law and the rise of alternative rationales undoubt
edly took their toll on the judiciary, the only branch that must justify
38
Our Founding Principles
its decisions in written opinions that are subject to the scrutiny
of the world. As time went on, those opinions were grounded
increasingly within the "four corners" of the written text, making
little if any reference to the higher law that stands behind that text.
The advantage of doing things that way, of course, is a certain
intellectual security and objectivity: the Court can always point to
the explicit language on which it grounds its opinion. That advan
tage can be deceptive, however, particularly if what emerges is a
less than complete and hence misleading reading of the text, espe
cially in its broad passages. In fact, the result too often is a narrow,
clause-bound jurisprudence, reflecting nothing so much as the lack
of an overarching, integrated theory of rights that gives content
and order to the Constitution's broad language. Lacking such a
theory, it is no surprise that the Slaughterhouse majority could find
in the text no right of the plaintiffs to ply their trade free from the
monopoly restriction the state had created.
Notwithstanding the shortcomings of the Slaughterhouse majori
ty's narrow constitutional positivism, that approach has dominated
our Supreme Court jurisprudence ever since, with selective excep
tions during two periods-in the early decades of the 20th century
and during the Warren and Burger Courts more recently. To under
stand how this j urisprudence and these jurisprudential shifts have
affected the growth of government, it is useful to distinguish two
constitutional avenues along which that growth has progressed.
On one hand, an accelerating accretion of government programs
instituted under a "general welfare" rationale-although usually
not proceeding explicitly under that constitutional provision-has
resulted in what today are massive transfers from taxpayers to
individual recipients, as discussed above. On the other hand,
countless programs today attempt to accomplish the same welfare
ends not by redistributing funds through the Treasury but by enact
ing regulations aimed at compelling private individuals and organi
zations to act in ways that are thought to be benefcial to other
private individuals and organizations. The power of Congress to
regulate commerce under the commerce clause of the Constitution
is usually the rationale for this second set of programs, which today
are ubiquitous. The question arises, however: how could either of
those two kinds of programs have been found to be constitutional
under a Constitution that was designed to limit government to
securing individual liberty?
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MARKET LIBERALISM
The General Welfare Clause. As discussed earlier, wealth transfers
that involve redistribution through the Treasury arose slowly, in
the face of political opposition grounded in constitutional principle,
and, in the end, without clear constitutional authority. Although
the general welfare clause was the implicit, and sometimes the
explicit, rationale for such programs, it was often not invoked by
proponents who felt themselves constrained to some extent by
Madison's interpretation of the clause: after all, why would powers
have been enumerated if Congress could, under the general welfare
clause, spend on virtually any project it deemed to be for the general
welfare? Thus, congressional spending during the 19th century
often began under an enumerated power but then expanded to be,
in effect, a general welfare expenditure. Sales of land under the
territorial power clause, for example, evolved into gifts of land for
agricultural colleges, then into gifts of proceeds from the sale of
land, and finally into gifts from the Treasury generally. Similarly,
with two early and small exceptions, not until 1867 were gifts of
money to private citizens made, and these were justified chiefly
under the war powers. In 1874, however, gifts to flood sufferers
were given under a theory of general welfare, a precedent that was
repeated seven times over the next 30 years.
Thus, by small steps Congress moved from clear, to less clear,
to no authority, creating limited programs that served later as prece
dents for more expansive programs. Background deyelopments
were not irrelevant to this evolution. Indeed, our changing concep
tion of government only encouraged the process. Thus, as prece
dents accumulated, not only were constitutional questions replaced
by policy questions but the idea of government as the engine of
progress took on a life of its own.
What was especially distressing for constitutionalists, however,
was the absence of any secure ground on which to raise a challenge,
particularly after the Supreme Court decided in 1923 that neither
citizens nor states had standing to sue to enjoin the secretary of
the Treasury from making such expenditures. Echoing the Slaugh
terhouse majority, the Court in that case, Frothingham . Mellon,
refused "to assume a position of authority over the governmental
acts of another and co-equal department," leading Attorney Gen
eral William D. Mitchell to observe in a 1931 speech to the American
Bar Association that "no one has yet been able to devise a method"
40
Our Founding Principles
by which the constitutional validity of appropriations of the national
funds may be presented for judicial decisions.
Nevertheless, in 1937, in Halvering v. Davis, a challenge based
on the general welfare clause was presented against the New Deal's
Social Security Act. In that case, however, not only did the Court's
majority follow a decision handed down a year earlier that had
rejected Madison's understanding of the clause, but in repeating
its recent finding that the clause did serve as an independent source
of power for Congress to tax and spend-thereby gutting the doc
trine of enumerated powers-the majority went on to say that the
Court would not itself get into the question of whether a given
exercise of tha t power was for the general or for a particular welfare.
Shades again of Slaughterhouse, with the Court deferring to the
political branches. And with that, the Progressive Era's stream
of welfare programs, especially under Presidents Roosevelt and
Wilson, became a New Deal river.
The Commerce Clause. If attempts to restrain the growth of welfare
transfers failed, attempts to restrain the growth of regulatory trans
fers fared no better. Here, however, the opportunity to litigate was
greater since these transfers took place not through the power of
Congress to tax but through its power to regulate. The regulations
that today bestow benefits on some by regulating others-in areas
ranging from transportation to manufacturing, employment, hous
ing, discrimination, and on and on-constitute restrictions on the
liberties of those others. Because they do, they can be challenged
in the courts.
Once again, however, we have to determine first the source of
whatever power Congress may have, then examine the implications
for individual rights. Unlike the welfare programs, these schemes
are based on an independent source of power. The commerce
clause, unlike the general welfare clause, sets forth one of the
enumerated powers of Congress, giving that branch the power "to
regulate Commerce . . . among the several States." On its face,
the power would appear to be plenary, save for its limitation to
"commerce, " not other activities, and to commerce "among" the
states, not within them. Unfortunately, both those limits are gone
today, and the power is indeed all but plenary. Accordingly, we
need to begin at the beginning, by placing the power in its historical
setting.
41
MARKET LIBERALISM
There can be little doubt about the principal purpose of the com
merce clause. Under the Articles of Confederation, state legislatures
had become dens of special-interest legislation aimed at protecting
local manufacturers and sellers from out-of-state competitors. The
result was a tangle of state-by-state tariffs and regulations that
impeded the free flow of commerce among the states, to the detri
ment of all. Only a national government could break the logj am.
Indeed, the need to do so was one of the principal reasons behind
the call for a new constitution.
The commerce clause was aimed, then, at giving Congress, rather
than the states, the power to regulate commerce among the states.
Its purpose was thus not so much to convey a power "to regulate"
in the affirmative sense in which we use that term today-as a
power "to make regular" the commerce that might take place
among the states. And in fact the so-called negative or dormant
commerce power, which restricts states from intruding on federal
authority over interstate commerce even when there has been no
federal legislation in a given area, operates largely in that way.
At bottom, then, the commerce clause was intended to enable
Congress to break down state barriers, to prevent states from
restricting the free flow of commerce among themselves. What has
happened in litigation over the years, however, is not unlike what
has happened with the Tenth Amendment. There, the principal
purpose was to make clear that ours was a government of enumer
ated powers, the balance of power being "reserved to the states
. . . or to the people. " Ignoring those final four words, the discus
sion, not unlike that over the commerce clause, has focused not
on the substantive question-how freedom might be secured-but
on the jurisdictional question-who should control, the federal
or the state government. The assumption that one or the other
government must control commerce goes all but unchallenged.
Yet once we think of the commerce clause as conferring not only
a negative but an affirmative power to regulate, questions about
how to limit the power come immediately to the fore. And noting
that the power to regulate interstate commerce is one of Congress's
enumerated powers only highlights the problem. For if that power
becomes all but boundless, as it has, the doctrine of enumerated
powers becomes an empty promise.
To see how that has happened, and how regulatory programs
have grown over the years, we need to consider the issues in the
42
Our Founding Principles
abstract for a moment. More precisely, we need to analyze the
relation between the purpose of the commerce power and its terms.
Again, those terms limit Congress to regulating "commerce, " not
other activities, and commerce "among" the states, not within
them. When Congress is further restrained by the original purpose
of the clause, a four-part test emerges: to be justified under the
commerce clause, a regulation must ( 1) facilitate the free flow of
(2) interstate (3) commerce (4) without violating the rights of any
party. Conditions 2 and 3 are those of the clause, of course. Condi
tions 1 and 4 stem from the purpose of the clause: when interstate
commerce is free from governmentally imposed restraint, private
parties are at liberty to make whatever agreements they wish, lim
ited only by the common law. Thus, any regulation that facilitates
the "free" flow of interstate commerce by restricting the rights of
some i order to give benefits to others would not pass the test. That
is not free but managed trade-trade managed for some other end.
Limited then to its original negative purpose, the commerce
power is largely unproblematic because it functions only to prohibit
state regulations that restrict the free fow of interstate commerce.
To be sure, there could be too much federal prohibition. But the
test would be whether the state regulation prohibited by the federal
power does in fact restrict the free flow of interstate commerce.
Similarly, an affrmative commerce power that executed certain
police power functions would be unproblematic if it met the four
part test. Thus, a regulation that clarified rights in uncertain con
texts or another that controlled the interstate shipment of danger
ous goods would present no problems-provided, of course, that
the police power specifications of such regulations were consistent
with the underlying theory of rights.
What happens, however, if conditions 1 and 4 are eliminated?
What happens, that is, if the commerce power is no longer
restrained by its original purpose but by its two limiting terms
alone? Can those terms bear the entire burden? Worse still, what
happens if purposes other than the original purpose start driving
the interpretation of the clause? Suppose, for example, that we
stop thinking of the clause as intended to facilitate the free fow of
interstate commerce by ensuring economic liberty and start think
ing of it instead as an instrument through which to pursue various
social goals? That would open up a whole new set of possibilities
43
MARKET LIBERALISM
for men and women of public vision, against whom parchment
barriers alone, especially in the hands of a clause-bound Court,
would provide little resistance.
Indeed, consider very briefly the expansion of the commerce
power over railroads. Like so many other areas, the railroad cases
are complicated by early government subsidies that encouraged
patterns of development that probably never would have arisen
from market forces alone. Thus arose local railroad monopolies,
which encouraged farmers and other shippers to demand and get
state regulation of railroad rates. Such regulation reaches far beyond
a state's police power, of course, and should have been actionable
as such; but it is hard to gainsay such controls where government
subsidies created the monopoly in the first place (again demon
strating how one intrusion in the market leads to still others). When
different states imposed inconsistent rates on the same interstate
carriers, however, suit was brought. In 1886, in Wabash, St. Louis
& Pacifc Railway v. Illinois, the Supreme Court held that only the
federal government could regulate interstate railroad rates. The
following year the Interstate Commerce Act was passed and so
the federal government was now in the rate-making business-a
quantum leap beyond making commerce "regular" among the
states by removing state barriers.
The Supreme Court never questioned this rate-making function,
of course, or tried to square it with the original purpose of the
commerce clause. Its concern rather was jurisdictional-whether
Congress or the states should set rates. Clearly, rate-making was
within the terms of the commerce clause: it was "commerce" that
was being regulated, not other activity, and commerce "among" the
states, not within them. But just as clearly, this was an expansion of
the commerce power well beyond its original purpose.
The expansion did not end there-and that is the lesson to be
learned from the railroad cases, so difficult to gainsay in them
selves-for once in the rate-making business, the Interstate Com
merce Commission found reason to extend its reach. Thus, the line
between interstate and intrastate regulation was breached in 1914
in the Shreveport rate case when the Court found that Congress
could extend "its control over the interstate carrier in all matters
having . . . a close and substantial relation to interstate com
merce" -this to prevent discriminatory interstate/intrastate rates,
4
Our Founding Principles
yet another displacement of the original purpose of the commerce
clause. And eight years later, in Wisconsin Railroad Commission v.
Chicago, Burlington & Quincy Railroad, the Court upheld the Trans
portation Act of 1920, . which replaced specific with comprehensive
railroad regulation, helping to cartelize the industry by imposing
comprehensive rate-of-retrn regulation. Thus, a constitutional
clause aimed at facilitating the competition that arises from the free
flow of commerce ended up being used to suppress competition.
The new attitude was perhaps best captured by the 1922 Court:
"Congress in its control of its [sic] interstate commerce system is
seeking . . . to make the system adequate to the needs of the
country by securing for it a reasonable compensatory return for all
the work it does. " Thus did "our'" system become socialized. In
effect, railroads were no longer private businesses but instruments
of public policy.
But if the reach of the commerce power was expanding, so too, of
course, were the rights of individuals receding. Thus, the Sherman
Antitrust Act of 1890, also passed under the commerce power,
prohibited private parties from entering into contracts in restraint
of trade. Shortly thereafter, the United States brought suit against
a combination of most, but not all, of the railroads that operated
between Chicago and the Atlantic coast, charging that those compa
nies had entered into a cooperative agreement with each other
that was aimed at shutting out competition. No longer having a
privileges and immunities clause on which to rely-for the Slaugh
terhouse Court's narrow reading of the clause (against the states)
might now be used in reading the version that was in the Constitu
tion itself-the defendants invoked their Fifth Amendment right
to freedom of contract, but to no avail. For in 1898 the Court found
in U. S. v. Joint Trfc Assocition that Congress had the power to
pursue a polcy of promoting economic competition. And failing to
distingush between private and public arrangements, it held that a
private agreement did in fact prevent competiton. It is no small irony
that 24 years later, when it upheld the Transportation Act of 1920,
the Court would approve a public arrangement that truly did prevent
competition in the railroad industry-by force of law.
The Decline of the Court. Notwithstanding its 1898 opinion, the
late 19th-century Court was in the beginning of its "Lochner" era,
45
MARET LIBERLISM
so called for the Court's 1905 decision in Lochner . Ne York uphold
ing the challenge of a New York baker, on freedom of contract
grounds, to a New York State statute limiting the hours that bakers
might contract to work. Over a series of cases, the Progressive
Era Court withstood a number of efforts to gut the Constitution's
economic guarantees in the name of public policy. But the cases
were uneven and never deeply grounded. It is as if the Court were
searching for its place in a world that was moving inexorably toward
public policy on all matters previously thought to be private.
The crisis came during the Depression, of course, when the politi
cal branches, driven by the mandates of 1932 and, especially, 1936,
undertook the reordering of our political arrangements not by
amending the Constitution but by ignoring it. President Roosevelt's
July 1935 letter to the House Ways and Means Committee speaks
volumes: "I hope your committee will not permit doubts as to
constitutionality, however reasonable, to block the suggested legis
lation. " When for a while the Court resisted the legislative ava
lanche, Roosevelt early in his second term tried to pack its ranks
with six additional members. The ploy backfired on the surface,
but the Court got the message, stepped aside, and let the modern
era begin. With the Court's decision in Carolene Products in 1938,
the foundations for our modern j urisprudence were laid. Thereafter
the Court would essentially defer to the political branches in all
matters pertaining to economic transfers and regulation. Only
when "fundamental" rights were at stake would the Court's scru
tiny be heightened.
Thus freed from constitutional restraints, the political branches
began to respond to all manner of interests, both general and spe
cial. Not surprisingly, the interests those interests pursued through
public channels grew increasingly short term, and increaSingly in
conflict with one another. Government, after all, is a zero-sum
game (after administrative costs, the sum is negative); one man's
gain is another man's loss. But the powers that prosper by the
game have grown skilled at packaging it otherwise, at telling us
that we can accomplish great things through government. And so,
measure by measure, the war of all against all has expanded until
the battles can no longer be ignored. Our flight from individual
responsibility is by now well advanced. Yet we are powerless to
change the reality that makes the flight so futile. Government will
46
Our Founding Principles
not, because it cannot, solve our problems. Our biggest problem
today is our reluctance to recognize that.
Recovering Our Principles
.
This brief review of the forces that have brought us from the
vision of the founding generation to where we are today concludes
with the jurisprudence of the New Deal because with that, quite
simply, the constitutional game was over. Building slowly since the
Civil War, the core idea of the new policy sciences, that government
could and should be responsible for a wide range of "social" prob
lems, came to the fore in the Progressive Era. Those used to thinking
of liberalism and progressivism as one may find it sobering to reflect
that in 1900, as the Progressive Era was getting under way, the
editors of the Nation could observe in a piece lamenting "the eclipse
of liberalism" t

at "the Declaration of Independence no longer

arouses enthusiasm; it is an embarraSSing instrument that requires
to be explained away. " With so fundamental a change in the climate
of ideas, it remained only to institutionalize that change. After
episodic resistance, the New Deal Court accomplished that at last
with alacrity on the part of some of its members, with reservations
from others, who felt, rightly or wrongly, that they could no longer
resist the political juggernaut. And so in 1938 the revolution was
completed, by the Court, the Constitution itself having changed
by not a word.
Constitutional Jurisprudence Today
There has followed a jurisprudence that is all but inscrutable to
the average American. Never mind that the Carolene Products case
from which it flows involved a piece of blatant special-interest
legislation, the Court read the case as standing for pure democracy
of a kind that it saw no need to review. So it took itself largely
out of the reviewing business, thus making the nation safe for
democracy, which of course is majoritarianism, which of course is
special-interest logrolling (for those willing to notice it). Indeed,
the reviewing function the Court reserved for itself would be con
centrated thereafter not on ensuring freedom but on enhancing the
democratic process: viewing the political arena as the essence of
our republic, the Court would limit itself largely to ensuring the
participation of all in that process. Thus, voting and speech cases
would find a receptive ear at the Court. Cases complaining that
47
MARKET LIBERALISM
the political process was restricting economic well-being would not.
And all who searched for the roots of this bifurcated jurisprudence
in the text of the Constitution would be disappointed, for it was a
product, pure and simple, of the vision of the Progressive Era,
brought to fruition through the politics of the New Deal.
As time has passed, we have seen this jurisprudence solidify:
first, by the accumulation of a massive body of transfer and regula
tory programs and, second, by the unwillingness of opponents of
those programs to challenge them on constitutional grounds.
Today, both liberals and conservatives are i n essential agreement
with the New Deal shift; their differences relate largely to the deci
sions that came from the Warren and Burger Courts in the 1960s
and 1970s. During that period of "judicial activism," a "liberal"
Court enlarged on the Carolene Prducts formulq when it started
resisting those outcomes of the political process that conficted with
"fundamental" rights the Court was finding in the "penumbras"
of the Constitution-consulting not the classic theory of rights in
this, as America's early courts had done, but "evolving social val
ues. " Conservatives complained that it was curious that those val
ues just happened to coincide with the values of America's emerg
ing liberal elite. Still, the differences between the two camps were
confined largely to this relatively limited area of the Court's jurisdic
tion-liberals wanting the Court to frustrate majoritarian prefer
ences in such areas as abortion, school prayer, the death penalty,
and the rights of criminal suspects; conservatives wanting the Court
to step aside and let majorities rule. In neither case has there been
a serious challenge to the fundamental finding of the New Deal
Court, that the political branches have far-reaching powers to regu
late our lives, especially in the economic arena.
Yet for all that, the nagging doubt that the New Deal Court
got it seriously wrong remains-indeed, grows as the scope of
government expands. Consider, for example, the expansion of gov
ernment's control over property owners, who today are all but
unable to move without offcial permission. The rights of property
owners should not be difficult to determine: after all, the Fifth
Amendment states plainly that private property shall not be taken
for public use without just compensation. In a given case, all a
court has to determine is ( 1) whether a government action takes
property for public use (by implication, there is no power to take
48
Our Founding Principles
for private use); (2) if so, whether the act is justified under the
police power, which enables government to prevent people from
using their property in ways that injure others; and (3) if not,
whether just compensation has been paid. Government is not pro
hibited by the takings clause from taking private property; it simply
has to pay for the property it takes rather than leave the costs of
public policy to be borne by the individual property owner.
Naturally, the compensation requirement puts a crimp on the
expansion of public policy: that, together with a concern for justice,
is why the Founders put it in the Constitution. Not surprisingly,
therefore, governments anxious to expand their power at no cost
to the public have sought both to narrow the definition of "prop
erty" and to expand the scope of the police power-and over time
the courts have acquiesced. Thus, in 1921, in Block v. Hirsh, the
Supreme Court was faced with a challenge to a wartime rent-control
statute-a classic regulatory transfer, which keeps rents low for
tenants by taking the rights of owners to charge market rates for
their rental units. Finding that "public exigency" outweighed any
such property right, the Court ruled the controls constitutional .
After seventy-one years and countless regulations, covering
everything from zoning to historic landmark preservation to com
prehensive land-use planning, the Court revisited the takings issue
in its last term in Lucas v. South Carolina Coastal Council. The facts
of the case were Simple: the South Carolina legislature had passed
a statute, aimed at providing a set of public goods ranging from
scenic preservation to tourism to wildlife habitat, the effect of which
was to deny Mr. Lucas his right to develop his property. For a
court willing to return to first principles, the case should have been
easy. Since the uses denied Mr. Lucas in no way threatened others,
the statute could not be justified under the police power; thus, as
a taking requiring compensation, it remained only to determine
the difference in the values of the land before and after the statute
was enacted and to order the difference paid to Mr. Lucas.
Unfortunately, the Court was unprepared to reach so principled
a solution. Instead, Justice Antonin Scalia, writing for the Court's
majority, took note of the Court's "70-odd years" of regulatory
takings jurisprudence in which "we have generally eschewed any
'set formula,' . . . preferring to 'engage in essentially ad hoc, factual
inquiries. "' Rather than jettison that jurisprudence, which Justice
49
MARKET LIBERALISM
John Paul Stevens once called "open-ended and standardless,"
Scalia tried instead to draw upon it. Thus, he distinguished cases
in which regulations deny " all economically beneficial or productive
use of land" from cases in which regulations leave some uses to
the owner, noting that plaintiffs in the latter kinds of cases would
not necessarily, even ordinarily, get relief. Since Mr. Lucas's loss
was nearly total, he should get relief on remand, Scalia concluded.
As for the millions of other Americans who suffer less than total
losses at the hands of federal, state, and local regulators, "takings
law is full of these 'all-or-nothing' situations. " Indeed, failing com
pletely to distinguish takings of rights from diminutions of value,
Scalia stretched for the Progressive Era rationale that "government
hardly could go on if to some extent values incident to property
could not be diminished without paying for every such change in
the general law. "
Ideas Have Consequences
Deference to government is thus by now deeply entrenched in
a body of precedents-by no means economic precedents alone
that the Court appears quite unwilling to revisit, however constitu
tionally unwarranted they may be. In fact, then-judge Scalia said
as much in 1984 in a Cato Institute debate with Richard Epstein on
the subject of judicial protection for economic liberty, although he
grounded his unwillingness not simply on his view that "the posi
tion the Supreme Court has arrived at [in rejecting substantive
due process in the economic field] is good" -about which he said
nothing further as a matter of constitutional law-but primarily on
misgivings about whether "activist" courts would do their job well.
On one hand courts might extend their activism beyond the eco
nomic arena, which deeply concerns Scalia; on the other hand they
might find economic "rights" that are quite without foundation.
Those are not idle concerns, to be sure, but as Epstein observed
in response, constitutional responsibility aside, they are no reason
to defer to the political branches, where the risks of failure are at
least as great.
Judge Scalia went deeper in that debate, however, to observe
that "a guarantee may appear in the words of the Constitution,
but when the society ceases to possess an abiding belief in it, it
has no living effect. . . . Even Brown v. Board of Education," he
50
Our Founding Principles
continued, "was only an elaboration of the consequences of the
nation's deep belief in the equality of all persons before the law. "
Because he could detect no "national commitment to most of the
economic liberties generally discussed that would enable even an
activist court to constitutionalize them," Scalia concluded that to
seek to develop that sentiment "by enshrining the unacceptable
principles in the Constitution is to place the cart before the horse. "
Thus, "the first step" is to recall society to that belief i n the impor
tance in economic liberty that the Founders shared-to create "a
constitutional ethos of economic liberty. "
Setting aside Justice Scalia's larger point for the moment, "the
economic liberties generally discussed" do not have to be "constitu
tionalized" -much less by an "activist" Court. They are already in
the Constitution. They need simply to be recognized and enforced
by a "responsible" Court-a Court responsible to the Constitution
its members swear to uphold. That is not judicial activism. It is
judicial responsibility. Moreover, it requires no "national commit
ment" for the Court to uphold the Constitution. Indeed, it took
federal troops to enforce Brown v. Board of Education. And more
recently, when the Court decided in U. S. v. Eichman that flag
burning was constitutional-a decision in which Justice Scalia him
self concurred-there was hardly a national commitment behind
that decision. No, the point of having a Court, as Madison said,
is to have an institution that can serve as "the bulwark of our
liberties. " To be such a bulwark, however, the Court must have
both convictions and the courage of those convictions. Today, both
are lacking. The climate of ideas has sapped the convictions that
give life to the bare text of the Constitution. And when those
convictions fail, courage goes with them.
Justice Scalia's larger point, then, that there is a deep connection
between the climate of ideas and the capacity of the Court, cannot
be ignored. The Court must do its job, to be sure, but it does not
work in an intellectual vacuum. For too long, the climate of ideas
in America has been molded by people and institutions that in many
respects are profoundly out of step with our founding principles,
principles that today are taking root in many other parts of the
world. Perhaps it is because those others have known personally
the tragedy that befalls a people when it follows the path of public
policy to its end that wisdom has at last set in. One would hope
51
MARKET LIBERALISM
that in America we will not have to learn that lesson from experience
alone.
And in this, we can take comfort from the fact that our Constitu
tion is still intact, despite the damage we have done to its meaning.
And the English language is still essentially what it was when the
document was written. What has changed is our confidence in the
ideas that stand behind that document and those words. And that
is unnecessary and unwarranted. Indeed, much has been done in
recent years to give force and foundation, to say nothing of clarity,
to the belief of the founding generation in natural law. But even
absent that, what else is there but natural law? Only force. Yet to
resort to force is to give up all pretense to legitimacy. That is not
what either our political leaders or our people do. They all pretend
to legitimacy. The job, then, is to get to the real foundations of
legitimacy, and those can be found only in a higher law of natural
rights.
It is the clarifcation of these ideas, then, that is the principal
business ahead of us. That means showing, for example, that the
business of government is doing right, not good, between which
there is all the difference in the world. Few would doubt the sincer
ity of at least many of those who today call for government to do
good. What is needed is repeated demonstration of how doing
good for some by doing wrong to others is wrong. Yet it is just
that wrong that constitutes the stuff of so much of our government
today.
And these lessons must be raised in every public forum. Who
cannot but be impressed by the constitutional arguments that charac
terized the debates in Congress in the last century? The courts
are not the only forum for constitutional debate. Indeed, those
arguments deserve to be heard everywhere because they are the
arguments that define us as a people. Today, we are out of sympa
thy with our founding principles. Is it any wonder, when we are
out of sympathy with our deepest selves, that there is trouble in
the land? The time has come to recover those principles and to
take personal responsibility for our lives. Nothing less will do, for
nothing less will free us as a people.
52
J. Reclaiming the Political Process
Edward H. Crane
Politics in America has slowly evolved into a rigid, closed system.
It is a system designed not just to protect incumbents, but to protect
the status quo. Our democracy is in danger because elections have
become the closest thing to being rigged: they are, for the most part,
lifeless, ideologically hollow show elections with gerrymandered
districts, voter indifference, and absurdly high reelection rates.
Election night celebrations, dutifully reported on television, would
feature empty halls absent the politicians' enormous staffs, the
grinning special interests, their families, and assorted hangers-on.
H American industry is being choked by excessive taxation and
layer upon layer of regulations, the American political process is
nearly comatose. Ironically, the bipartisan efforts of incumbents
to protect themselves from competition have perhaps been too
successful. The deafening silence from the American people at
election time, from the statehouse to Congress-as evidenced by
low voter turnout and even lower enthusiasm for the candidates
has increasingly drawn the attention of the media and various self
appointed public-interest groups.
From Common Cause to the television networks there is a steady
drumbeat to do something about the political malaise-not appar
ently to change the policies that the current system is generating,
but to enlist a little popular support for those programs. Invariably,
however, the solutions proffered by establishment institutions
would further rigidify the political system by funding campaigns
with taxpayer dollars and limiting campaign expenditures. But gov
ernment involvement in the political process is the primary source
of the problems we face. To restore vibrancy to American politics
we need to look elsewhere. We need to look to the term limitation
movement and to a removal of campaign contribution limits.
53
MARKET LIBERLISM
Term Limits
The nationwide movement to limit the number of terms state
legislators and members of Congress may serve received a tremen
dous boost in the November elections when 14 of 14 states, includ
ing California, Michigan, and Florida, approved term limit initia
tives. Most of those initiatives limited the respective states' congres
sional delegates to three terms in the House and two terms in the
Senate. If term limitation passes constitutional muster, one-third
of Congress will be term limited. Supporters of the concept hope
that will constitute a large enough contingent to force the issue to
the floor of Congress for debate (something that heretofore has
been systematically blocked) . Once a constitutional amendment is
proposed, the theory goes, there will be intense pressure to vote
yes, with 75 percent of the constituents back home favoring term
limits.
Opponents of term limits put forth four basic reasons for rejecting
the idea. First, they argue, term limitation is a restriction on democ
racy-we should be able to vote for whomever we please. But the
electoral process already restricts access to the ballot. State election
laws require a minimum number of signatures for minor party
candidates to get on the ballot. The Constitution itself precludes
us from electing as president anyone who is not born in the United
States or who is under the age of 35. That said, the reality is that
term limits will enhance the democratic process. Open seats are
always more hotly contested than are seats held by incumbents
seeking reelection. Under term limits, at least a third ot the House
seats would be open in every election, and even those that were
not open would invite spirited competition from opponents seeking
name recognition in hopes of gaining the soon-to-be-open seat.
Popular interest in elections would be increased and the democratic
process enhanced as a result of term limits.
A second reason put forth by opponents is that term limits would
deny us experienced legislators. To which proponents might justi
fiably respond, "Let's hope so. " In fact, it was the experienced
legislators who gave us the savings-and-Ioan crisis by expanding
federal deposit insurance, thereby guaranteeing that the newly
deregulated thrifts would speculate with deposits from investors
utterly uninterested in the integrity of the financial institution with
which they were dealing. It was the experienced legislators who
54
The Political Process
gave us the 1990 budget deal that actually placed the federal govern
ment on a faster spending track over the following five years than
it had been on during the previous five years. The greatest tax
increase in American history was instituted without eliminating a
single one of the 4, 000 domestic federal programs or, indeed, sack
ing a single federal employee. Such is the record of America's
experienced legislators.
Third, it is argued that lobbyists, federal bureaucrats, and con
gressional staffs will run amuck without senior members of Con
gress to hold them in check. But a recent Gallup Poll of just those
three groups showed that nearly 60 percent of them opposed term
limits. Except for politicians themselves, those three groups are the
strongest opponents of term limits to be found anywhere. The
lobbyists have invested years in cultivating the specific members
of Congress who take care of their interests. They hardly want to
"retrain" new people every four or six years. (Indeed, an added
benefit of term limitation is that it would reduce the incentives for
political action committees and other special interests to invest in
politicians. ) Federal bureaucrats are generally on much better terms
with senior members of Congress who have made their accommo
dation with the bureaucracy than they are with freshmen legislators
who often take an adversarial stance with bureaucrats on behalf of
their constituents. As for congressional staff, they quite obviously
gain personal power as their member gains seniority and power.
Of all the groups in the Gallup Poll, they were the most overwhelm
ingly opposed to term limits.
Finally, it is said that term limitation, if implemented on a state
by-state basis as it now is, will reduce the "clout" of those states
with limits relative to those states without them. That argument is
credited with having defeated the Washington State term limit
initiative in 1991 . The truth is that there is no positive correlation
between the seniority of state congressional delegations and the
federal pork handed out to the states. But let's assume there is.
Would that be a good thing? Is that what the Framers had in mind
for Congress-a giant free-for-all in which each state competed to
get more per capita federal largesse than the next? Presumably not.
In any case, the impact Congress has on us as individuals is much
greater in terms of national legislation than it is in terms of state
specific pork. We should seek members of Congress who have
55
MARKET LIBERALISM
sensible approaches to national policy rather than an aptitude for
logrolling.
Opposed to these weak reeds of opposition to term limits, there
are two powerfully compelling arguments in favor of the concept.
First, it overcomes what is clearly an adverse preselection process
in existence today. The American Founders believed that for democ
racy to work, it must be representative. Yet today we have a Con
gress that is 92 percent male, and 46 percent of the members have
law degrees. Why? Because those who are successful in the private
sector-whether they are entrepreneurs, teachers, computer pro
grammers, or farmers-consider the prospect of running for Con
gress and realize they'd have to be there 10, IS, or even 20 years
to have any real infuence under the current regime. They may be
perfectly willing to spend some time in Congress as a public service,
but not if their time has no impact. They like what they do for a
living in the private sector and are disinclined to spend a significant
portion of their lives as politicians. Yet those are precisely the kinds
of men and women who should be in Congress.
In contrast, there are those like former California state assembly
man Mike Roos, who complained that the term limit movement
was out to take his career away from him. In a debate over the 1990
California Proposition 140 term limit initiative (which eventually
passed, prompting Roos to retire), he argued that he had wanted
to be a legislator all of his life. He had studied political science in
college, gotten a masters degree in public administration, taken a
job with a state assemblyman, and then run for and won his current
seat some 13 years ago. One would guess that Mike Roos might
also have been blackboard monitor (or crossing guard-whatever
political post was available) in the fourth grade. The problem, of
course, is that Roos's profile is all too common in state legislatures
and especially in Congress.
None of which is to suggest that the Mike Rooses of the world
are bad people, or have nefarious aims to undermine the Republic.
Quite the contrary. They undoubtedly embark upon their career
paths with the best of intentions. The point is simply that they are
not representative-in fact they are quite unrepresentative-of the
public they seek to represent. Members of Congress are supposed
to represent the private sector. If they are career politicians, they
are part of the public sector. They end up not telling government
56
The Political Process
what the people want, but instead lobbying the people to support
more government.
A strict, three-term limit for members of Congress would bring
a much more diverse-and representative-population onto the
ballot. Indeed, that has already proven to be the case in California's
state legislative races. People serving in Congress should view their time
there as a leave of absence fom their real jobs. Terms limits would
represent a major step away from professional politicians and
toward a true citizen legislature.
The second major reason to support term limits is that even
assuming we had a truly representative Congress, over time even
the best people can lose their perspective in the "culture of ruling"
that exists in the state capitals and inside the Beltway in Washing
ton, D.C. Common sense is the victim in an environment in which
one is constantly surrounded by other people-at work or socializ
ing at a Redskins game-whose job it is to spend other people's
money and regulate other people's lives.
The power, perks, and privileges of being a member of Congress
are slowly corrupting, not necessarily in the direct sense of the
House banking scandal, although that is a case in point, but in the
sense of losing one's humility and sense of proportion. There is
something unnatural about having people shove microphones in
your face day in and day out, seeking your opinion on everything
under the sun. Pretty soon, it's easy to overestimate the importance
of your opinion and think that perhaps you should codify it when
ever possible. In fact, groups like the National Taxpayers Union
have documented that the longer people are in Congress, the more
expansive (and expensive) their legislative initiatives become
whether they are conservatives or liberals.
It is important to recognize that the term limit movement is not
an aberration in American politics. The concept of rotation in office
has its roots deep in our colonial history and was, in fact, included in
the original Articles of Confederation. That it was not subsequently
included in the Constitution probably reflects the fact that the tradi
tion of serving in Congress and returning to one's real job was so
ingrained in our society at the time that it was deemed superfluous
to include it. On the other hand, there are those who maintain
that by the time the Constitution was debated there were enough
Americans who had tasted political power (something virtually
57
MARKET LIBERALISM
absent from the colonial period) that the omission may have been
conscious.
Regardless, the idea of term limits is time-honored. Evidence of
that abounds, but one of the most perceptive statements on the
subject was penned by two Englishmen, John Trenchard and
Thomas Gordon, in Cata's Letters (after which, it should be noted,
the Cato Institute is named).
Men, when they first enter into magistracy, have often their
former condition before their eyes: They remember what
they themselves suffered with their fellow subjects from the
abuse of power, and how much they blamed it; so their
first purposes are to be humble, modest and just; and proba
bly, for some time, they continue so. But the possession of
power soon alters and vitiates their hearts, which are at
the same time sure to have leavened and puffed up to an
unnatural size, by the deceitful incense of false friends and
by the prostrate submission of parasites. First they grow
indifferent to all their good designs, then drop them. Next,
they lose their moderation. Afterwards, they renounce all
measures with their old acquaintance and old principles,
and seeing themselves in magnifying glasses, grow in con
ceit, a different species from their fellow subjects. And so,
by too sudden degrees become insolent, rapacious and
tyrannical, ready to catch all means, often the vilest and
most oppressive, to raise their fortunes as high as their
imaginary greatness. So that the only way to put them in
mind of their former condition, and consequently of the
condition of other people, is often to reduce them to it, and
to let others of equal capacities share the power in their
turn. This also is the only way to qualify men, and make
them equally fit for domination and subjection. A rotation
therefore, in power and magistracy, is essentially necessary
to a free government.
That argument is as sound today as it was when it was written
250 years ago. By reducing exposure to the culture of ruling and
increasing the diversity of people seeking office, term limits will
restore respect for the institution of Congress. The common sense
and integrity of the American people will be more accurately
reflected in a term-limited Congress, and that is something that is
essential to the preservation of a vigorous democracy.
58
The Political Process
End Contribution Limitations
In 1974 Congress passed one of the few laws of recent decades
that has achieved its true intent. The Federal Election Campaign
Act, as a review of the debate that took place in Congress will
confirm, was designed to shore up support for the two-party system
in the wake of the Watergate scandal and growing disenchantment
with politics in general. Ironically, one of the leading proponents
of the bill on the House floor was John Anderson, an Illinois Repub
lican who subsequently challenged the two-party system with an
underfunded (thanks in large measure to the FECA) independent
presidential campaign. Anderson explicitly warned his colleagues
that without the radical campaign reform law, they faced the pros
pect of viable third parties and the kind of multiparty system that
is prevalent in other Western democracies.
The FECA as originally passed would have strictly limited expen
ditures on and contributions to federal campaigns while providing
federal funding for such campaigns and for the presidential nomi
nating conventions of the two major parties. In January 1976 the
U. S. Supreme Court, in a decision of contorted logic remarkable
even for that incoherent institution, ruled that limits on campaign
expenditures offended the intent of the First Amendment, but limits
on campaign contributions did not. Federal funding of congres
sional campaigns was struck down, but federal funding of presiden
tial campaigns and party conventions as not.
In his excellent dissent from the broader Supreme Court ruling
on the FECA, Chief Justice Warren Burger pointed out that "limiting
contributions, as a practical matter, will limit expenditures and will
put an effective ceiling on the amount of political activity and debate
the Government will permit to take place. " To Burger, "contribu
tions and expenditures are two sides of the same First Amendment
coin. "
Former senator Eugene McCarthy, one of the appellants challeng
ing the law, agreed, stating: "I think there are two areas of our life
which ought to be really somehow exempted from government
support, and therefore government influence. One is religion, and
the other is politics. "
Senator McCarthy's own experience i n presidential politics i s a
pointed example of why unlimited campaign contributions are
contrary to the conventional wisdom-essential to the preservation
59
MARKET LIBERLISM
of a free society. In 1968 opposition to the war in Vietnam was
growing dramatically-not j ust among leftist hippies and fellow
travelers, as the leading politicians of both parties claimed, but
among the American middle class. The tension created by the effec
tive disenfranchisement of tens of millions of Americans was palpa
ble and our society was in danger of having its social fabric ripped
apart by pent-up frustration.
Onto that scene strode the lanky senator from Minnesota, a
maverick liberal, former baseball player, and hardly a threat to the
American way of life. Yet he had no national political base. His
campaign-the only national effort based primarily on opposition
to the Vietnam War-was able to get off the ground because of the
support of a handful of wealthy liberals, Stewart Mott among them,
who made large, six-figure contributions to the McCarthy effort.
The energy thereby released by the McCarthy candidacy was so
powerful that it forced an incumbent president, Lyndon Johnson,
to shut down his reelection campaign. Eugene McCarthy, to this
day, states unequivocally that had the FECA been in place in 1968,
his campaign would have drawn little or no attention.
American history would have been rewritten if the FECA had
existed eight years earlier. We have no way of knowing how the
natural development of American society has been distorted in the
years following its enactment. We do know that it is not the proper
role of government to regulate elections in such a manner as to
distort their outcome.
The case against campaign contribution limits is not an easy one
to make. There is something intuitively "fair, " at first blush, about
limiting the influence wealthy people might have on elections. But
a closer look at the issue reveals a different perspective, at least if
we have faith in the idea of democracy. While incumbent office
holders and "public interest" groups tell us that limits are a way
for government to protect us from manipulation by the wealthy,
the truth is, as the McCarthy candidacy affirms, precisely the oppo
site. The truth is that the tens of thousands of individuals in America
with the financial wherewithal to bring political issues to our atten
tion represent a potentially effective check on manipulation by
govern men t.
One of the contortions of the Supreme Court ruling on the FECA
was that candidates for federal office could spend as much of their
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The Political Process
own money on their campaigns as they wished, because you can't
"contribute" money to yourself. Hence, individual candidates are
making expenditures, rather than contributions, when they give to
their own campaigns. Thus, Ross Perot has legal privileges as a
candidate that we mere voters do not.
But there is nothing wrong with candidates' spending aU they
want on their own campaigns. Indeed, that "loophole" that the
Court carved in the FECA underscores the dangers of contribution
limits. Without that loophole, how could the American people have
made such a dramatic statement about their dissatisfaction with
the choices being offered by the two major parties? The problem
lies not in Ross Perot's ability to spend significant sums of money
on his own campaign, but in the illegality of his spending similar
sums on other candidates. In fact, if he could have contributed
large sums to someone else, one could argue that he would have
been hard pressed to justify his own candidacy. Would not, say,
Paul Tsongas have been a more viable candidate to tackle the deficit
issue than a Ross Perot with all the negative baggage his campaign
had to carry?
Those with a kind of Common Cause, patronizing attitude
toward the average American assume as a matter of faith that
money is the root of all political evil-that unrestricted contribu
tions would thoroughly corrupt our political process. Yet with con
tribution limits in place, we've seen more corruption in the two
political branches of government than at any time in our history. At
least part of that corruption is a direct result of the noncompetitive
electoral process generated by the vast array of incumbent-protec
tion legislation, contribution limits included. Even with Ross Perot
factored in, the 1992 presidential campaign spent only about $3 per
voter. The average congressional contest spends a little over $1
per voter. It can be argued that we are spending far too little on
campaigns, given the enormous impact their outcomes have on
our lives.
Besides, there is substantial evidence that, with full disclosure,
voters can decide for themselves whether large contributions
should or should not be a factor in voting for a candidate. The list
of failed multimillionaire candidacies is substantial, going back to
John Connally's $10 million, one-person delegation to the 1980
Republican National Convention. More recently we've seen voters
61
MARKET LIBERLISM
reject department store heir Mark Dayton's $7 million campaign
for the U. S. Senate in Minnesota, perfume heir Ron Lauder spend
over $13 million on his futile effort to become governor of New
York, and Clayton Williams do little other than become a source
of ridicule with his $8 million contribution to his campaign for
governor of Texas.
To be certain, wealthy candidates often do prevail. Jay Rockefel
ler's $10 million loan to himself for his victorious 1984 U. S. Senate
campaign in West Virginia is an example. But the important point
is that voters can, and often do, reject such candidates. There is
nothing wrong, in any case, with a candidate's forsaking large
contributions as a matter of principle, or at least as a campaign
strategy. Lawton Chiles did just that in his 1990 race for governor
of Florida; he accepted no contributions in excess of $100 and won
a convincing victory. Of course, he was a former U. S. senator from
Florida and had the advantage of name recognition, lack of which
might preclude another candidate's adopting such a strategy.
Contribution limitations for political campaigns greatly favor the
two major parties and the well-recognized names within those
parties-typically the targets of the term limit movement: career
politicians. For Democrats and Republicans to pass such a law is
analogous to Walmart's getting a law passed that allows anyone
to compete against it in the retail business, but only up to $1, 000
in advertising. New companies, new ideas, new candidates all need
large amounts of seed capital to have a chance to challenge the
status quo. We should not have to depend on the candidates them
selves to have the wealth to make that challenge.
One of the many advantages of capitalism over state monopolies
is that entrepreneurs have thousands of sources of capital. A person
with a great new product need find only one person willing to put
up the funds to give the product a market test. Everyone can say
no to the venture capital project except one person, and our whole
nation of consumers benefits, if the product is, in fact, worthwhile.
Were entrepreneurs required to get their funding from a Federal
Entrepreneurs Commission, it's a good bet the commission would
go along with the majority of "experts" and deny the request.
Americans have a right to expect as dynamic a political system
as they do an economic system. Contribution limitations have been
passed into law for the same self-serving reasons that corporations
62
The Political Process
lobby for protectionist bills of their own, complete with all the
"public interest" rhetoric. But instead of ensuring an open, dynamic
election process, the FECA has had a chilling, rigidifying impact
on the choices available to Americans each November.
(The fact that so-called independent expenditures may be made
by individuals in unlimited amounts should not be taken as a seri
ous rebuttal to the case against contribution limitations. The law
is complicated and intimidating-only a handful of people make
independent expenditures each election. Even then they are not
allowed to communicate with the candidate or his campaign, much
less try to induce someone to run on the basis of forthcoming
support. )
A major benefit of "outsider" campaigns funded by large contri
butions-quite aside from ousting unpopular presidents, as in the
case of Eugene McCarthy-iS that they can raise issues that the
establishment, career politicians who dominate the election scene
will not. The Cato Institute is not alone, for instance, in suggesting
that the Social Security system is a looming financial disaster for
America if something is not done soon. Yet no politician running
for federal office under the current system is willing to say anything
suggesting there might be a serious problem with Social Security.
That Ross Perot at least raised the issue, albeit tentatively, is indica
tive of the potential a more dynamiC political system holds.
Finally, and quite aside from the practical benefits specifically
related to the electoral process, the elimination of campaign contri
bution limits represents something else. For it is, at bottom, consis
tent with the nature of the kind of free society the United States
of America is all about. As Senator McCarthy put it, "The signers
of the Declaration of Independence did not write 'We mutually
pledge to each other our lives, our fortunes up to $1 ,000 and our
sacred honor. ' " There are indeed risks associated with living in a
free society, but they pale in comparison with the risks involved
with turning over to government responsibility for decisions we as
independent citizens should properly make ourselves. In his dis
sent on the constitutionality of the Federal Election Campaign Act,
Chief Justice Burger wisely wrote, "There are many prices we pay
for freedoms secured by the First Amendment; the risk of undue
infuence is one of them, confirming what we have long known:
freedom is hazardous, but some restraints are worse. "
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MARKET LIBERALISM
The First Amendment protects the right of millionaires who own
newspapers, such as Katharine Graham of the Washington Post, to
spend tens of millions of dollars editorializing in favor of certain
candidates, or shaping news coverage to reflect a given philosophi
cal perspective. Millionaire cartoonist Garry Trudeau, whose work
appears in hundreds of papers across the country, gave Bill Clinton
millions of dollars' worth of promotion by devoting most of his
strips to bashing President Bush and Ross Perot during the last two
months of the campaign. Conservative radio talk show personality
Rush Limbaugh did the same for George Bush. Would anyone
seriously deny those wealthy people the right to do those things?
Is it not obvious that the political debate is more vigorous thanks
to their efforts? But why should they have the opportunity to be
important figures in political debate while others are denied it
simply because they chose a career other than the media?
As so much of mankind throughout the world seems to be grasp
ing the benefits of limiting government primarily to protecting
individual liberty, it is tragic that here in the United States, where
the seeds of the worldwide market-liberal revolution were created,
we seem to be headed for a more closed system, one controlled
by professional politicians whose interventionist ambitions would
appear to have no limits. The entrenched political status quo must
be challenged if we are to preserve our heritage as a free, open,
and pluralistic society. The two proposals suggested in this chap
ter-one popular at the moment, and one not-would work well
together to reinvigorate our stagnant democracy.
6
ART
COMOMlC OLlCY
+. Balance the Budget by Reducing
Spending
William A. Nisknen and Stephen Moore
Most American families, firms, and state and local governments
have recently reduced their spending in response to a lower-than
expected growth of income. Most, that is, other than the federal
government. Real federal domestic spending during the Bush
administration increased at a higher rate than during any adminis
tration since that of Kennedy. The combination of a rapid growth
of federal spending and a slow growth of tax revenues increased
the federal deficit from $153 billion in fiscal year 1989 to an estimated
$331 billion in FY93.
The long-term projections are even more discouraging. The Con
gressional Budget Office, assuming no increase in real discretionary
spending and no intervening recession, forecasts a federal deficit
of $400 billion in fiscal year 2000 and over $500 billion in fiscal year
2002. In the absence of major changes in federal fiscal policy or an
increase in economic growth, the future federal deficit will probably
be even higher than forecast. The huge federal deficit will have to
be financed at a time when U. S. private savings are expected to
remain low and net borrowing by other nations is expected to
increase.
One might have hoped that the deficit would be addressed in the
1992 campaign, but it was not. Both President Bush and Governor
Clinton promised to finance their new proposals by offsetting
changes in spending and taxes, but neither offered any substantial
proposals to reduce the baseline deficit. Only Ross Perot made a
major issue of the federal deficit, but he did not defend the specifc
proposals of the plan that had been prepared for him. Several
new citizen groups pressed candidates for Congress to commit to
reducing the deficit. And only a few more votes are needed in
Congress to approve a balanced budget-tax limitation amendment
for subsequent ratification by the states.
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MARKET LIBERALISM
We should have learned the following lessons from the economic
and fiscal record of the past decade.
A federal deficit does not lead to a corresponding increase in
private savings. Instead, a federal deficit leads to some combina
tion of reduced domestic investment and increased U.s. borrow
ing from other nations. In effect, we are increasing the tax burden
on future generations, who had no role in authorizing the present
debt. Incurring such debt may be appropriate to finance a war
or a temporary increase in public investment, but it is not a viable
long-term fiscal policy.
Economic growth will not be sufficient to reduce the federal
deficit without a major change in current fiscal policies, but eco
nomic growth is a necessary condition.
An increase in federal taxes is likely to be counterproductive
because it will reduce economic growth and invite an increase
in federal spending.
Major reductions in the main federal spending programs are
necessary to reduce the growth of total federal spending.
Although there is plenty of "pork" and other waste in the federal
budget, reducing that waste would not reduce spending suffi
ciently, nor would it be easy to do. (Most wasteful expenditures
are made because someone in authority wants them. )
The primary implication of those lessons is that we cannot long
avoid a major reduction and restructuring of the major federal
spending programs. Many state governments have already made
the hard choices reduced spending entails. Making those choices
will not be much fun for our federal politicians, but if they are
not willing to do so, they are part of the problem and should be
replaced.
The federal budget cn and should be balanced before the end of
the decade by reductions in spending, not tax increases. Herein we
describe the program changes and the magnitude of the spending
reductions that should be considered to achieve that goal. Our
proposed changes, of course, are not the only ones possible; other
combinations of reductions would also work. The specific spending
reductions we propose are based on the following general criteria.
Maintain mandatory spending. The only types of spending that
we regard as fixed obligations of the federal government are
68
Balance the Budget
interest payments on the federal debt, payments for other goods
and services previously supplied, expenditures for deposit insur
ance, and the real pension benefits of retired federal employees
and current recipients of Social Security.
Respond to changed conditions. The most important changed
condition, of course, is the end of the Cold War. That has primary
implications for the appropriate size of the defense budget.
Correct unsustainable conditions. For some years, spending for
medical care has increased at roughly twice the rate of the gross
domestic product. That increase cannot be sustained, and it is
better to correct the condition early.
Reduce high-income benefits. A significant part of federal spend
ing generates benefits for high-income people. Those benefits
should be reduced.
Eliminate low-priority programs. Hundreds of unnecessary
domestic programs should be abolished or financed by state and
local governments.
We suggest that any serious proposal to reduce the deficit should
address the implications of each of those criteria.
The case for balancing the budget by spending reductions, rather
than tax increases, is based on a judgment that the federal govern
ment has grown too large and that most people do not get their
money's worth from government spending. The popular vote for
the presidential and gubernatorial candidates of the incumbent
party, for example, generally declines in response to an increase
in real per capita spending and taxes since the prior election. Simi
larly, net migration among the states is generally from high-tax to
low-tax states. Those two patterns are inconsistent with a belief
that increased government spending is broadly popular. Total gov
ernment spending is now about $20,000 per household; we doubt
that most Americans find that the benefits of government spending
are worth the cost. Moreover, each additional dollar of tax revenue
collected now reduces the output available for private use by over
$1 . 50; we doubt that there are more than a few federal programs
for which the value of the last dollar spent is worth that additional
cost. Ask yourself: should the budget be balanced by reducing
government spending or by increasing your taxes? We doubt that
many Americans value most federal programs enough to support
69
MARKET LIBERALISM
higher taxes. For that reason, we outline a plan to balance the
budget by scaling down federal spending to a level that would be
broadly supported.
The Federal Budget Outlook
Table 4. 1 summarizes the (August 1992) Congressional Budget
Office estimate of the FY93 budget and their forecast of the budget
through FY98. First, it is important to recognize that the CBO
forecast probably underestimates future outlays; total real outlays
subject to annual appropriations are assumed to be reduced by
about 10 percent through FY95 and to be constant in subsequent
years. Table 4. 1, however, is sufficient to convey the magnitude
of the spending reductions necessary to balance the budget. Assum
ing, as a first approximation, that changes in federal spending do
not affect economic growth, inflation, and interest rates, total out
lays in FY98 must be reduced by $31 1 billion to balance the budget
by the end of that year. Total program outlays need not be reduced
Table 4. 1
THcIcOckAttOCcititCCk[ittiCrsCrDCttAks)
Fiscal Year
93 94 95 96 97 . 98
Outlays
Defense 297 284 284 287 290 293
Social Security 302 318 336 354 374 394
Medical 226 251 280 314 349 389
Other 482 487 491 507 520 565
Total 1, 307 1, 340 1,391 1, 462 1, 533 1, 641
Deposit insurance 49 17 5 -7 - 16 -20
Offsetting receipts -67 -69
-
72
-
74
-
76
-
79
Net interest 204 223 244 263 284 303
&
&
Total 1, 493 1, 511 1, 567 1, 644 1, 745 1, 845
Revenue 1, 162 1, 242 1, 323 1,390 1,455 1, 534
Deficit 331 268 244 254 290 311
Debt 3, 326 3,597 3, 847 4, 167 4,403 4,720
Secc C8O, August 1992.
70
Balance the Budget
quite that much, because early reduction of outlays would also
reduce the growth of net interest payments.
Table 4. 1 also makes it clear that a substantial reduction of the
major federal programs is necessary to balance the budget by spend
ing restraint; as of FY98, for example, three programs-defense,
Social Security, and medical care-are expected to account for about
two-thirds of total program outlays. In the absence of a substantial
reduction in spending on those programs, real spending for all
other activities of the federal government would have to be reduced
by more than 50 percent to balance the budget. And finally, Table
4. 1 illustrates that current levels of spending for several federal
budget items are not sustainable. Medical care, net interest pay
ments, and total federal debt held by the public are each expected
to increase as a percentage of total national output. A "politics as
usual" approach to the federal budget would only defer the neces
sary hard choices, increasing the fiscal problems of the next admin
istration.
The Path to a Balanced Budget
To balance the budget, we propose a five-step approach based
on the criteria summarized at the beginning of this chapter.
1 . Reduce the defense budget in response to the end of the Cold
War.
Z. Reduce the rate of increase of real Social Secnrity benefits for
future retirees.
3. Sequester 4 percent of the outlays for all other domestic pro
grams in the second half of FY93 and freeze total real outlays
for those programs from FY94 through FY98.
4. Reduce the rate of increase of spending on medical programs
consistent with the sequester and freeze.
5. Reduce outlays for other domestic programs consistent with the
sequester and freeze.
The following subsections make the case for each of those steps
and present rough estimates of the consequent budget savings.
National Deense
The Cold War is over. We won. And the Soviet Union has col
lapsed. We do not now face any Significant military threat to our
vital national interests except that of a missile attack on the United
71
MARKET LIBERLISM
States, against which we have no defense. No more dramatic
change in conditions could be imagined, but the Department of
Defense has been busy fantasizing new missions rather than reduc
ing forces to a level consistent with the new realities. Moreover,
the level of real defense spending proposed by President Bush is
about the same as it was during the peak of the Cold War in the
early 1960s. And Congress has resisted the cancellation of some
contracts and the closing of some bases because of concern about
local employment. One of the primary reasons for a commitment
to balance the budget is to overcome the bureaucratic and political
resistance to reducing programs and budgets even when there is
a substantial decline in the demand for them.
For over 40 years U. S. military forces have been designed to deter
or simultaneously counter one major adversary (the Warsaw Pact)
plus one or two minor adversaries in other regions, often referred
to as 1 or 2 war strategy. There is reason to question whether
U. S. and allied forces ever had that capability, but fortunately that
question is now moot. The basis for U. S. force planning should
now be changed in response to both the collapse of our major
adversary and the substantial increase in the military capabilities
of our allies.
Several responsible groups of defense analysts have recently
developed proposed U. S. defense programs that would reduce the
real defense budget to about one-half the FY92 level by the end of
this decade. Those programs differ in some details but share the
following general characteristics.
Strategic Forces
Eliminate land-based multiple-warhead missiles.
Limit the B-18 to carrying cruise missiles.
Limit purchase of B-2s to the 20 now authorized.
Deploy 17 Tridents, only 9 with 0-5 missiles.
Reorient Strategic Defense Initiative research and development
to large-area defense against small attacks.
General Purpose Forces
Reduce active ground forces to 6 Army divisions and 2 Marine
divisions.
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Balance the Budget
Reduce active tactical nir forces to 12 Air Force wings, 6 carriers,
and 2 (double) Marine air wings.
Phase out all combat units in other countries.
Substantially reduce the rate of force modernization.
Increase relative reliance on Reserve and Guard forces.
Research and Development. Maintain active R&D to assure techno
logical leadership and ability to deploy new weapons in response
to increased threats.
Budget and Active Military Personnel
Reduce Department of Defense budget authority to $183 billion
by FY98.
Reduce active military personnel to 1 . 1 million by FY98.
The proposed force structure would be adequate to maintain a
survivable strategic nuclear force, sufficient active forces to meet
the types of minor threats that might arise with short warning, and
a sufficient mobilization base to respond to a major threat that
could only develop over a period of years. The proposed force
would not be enough to maintain a global military presence and
deploy a force the size of the one used in Operation Desert Shield,
but there are strong reasons to question whether either of those
capabilities is now worth the large cost. American weapons would
continue to be the best in the world. And the proposed defense
budget would be higher than that of any other nation and much
higher (adjusted for inflation) than in any peacetime year before
the Cold War. The dramatic change in global military conditions
since 1989 should make the defense budget a major source of the
savings necessary to balance the budget. The changes described
above would reduce total outlays for defense (including small out
lays by other agencies) to about $100 billion below the level now
projected for FY98.
Social Security
Social Security has been interpreted as a political contract
between the working-age population and people who are now
retired. We accept that implicit contract and do not propose to
reduce the real pension benefits of those who are now retired. That
eliminates the possibility of any substantial saving in Social Security
73
MARKET LIBERALISM
outlays in the near term, but it should not cause us to defer dealing
with the long-term problems of the system.
The new administration should consider two major reforms to
put Social Security on a sustainable basis. First, the increase in the
retirement age that is already scheduled should be accelerated.
Beginning in 1993 the retirement age (and early retirement age)
should be permanently increased by two months per year for the
next 30 years. That would mean that the age at which one would
receive full retirement benefits would be 66 in 1999, 67 in 2005, 68
in 201 1, and so on. Incrementally increasing the age for receiving
full benefits would be a substantial step toward cushioning the
impact of the demographic time bomb that will explode in the next
20 years when the baby-boom generation begins to retire. Without
a change in retirement age, the ratio of workers to retirees i s
expected to fall to less than 2 to 1 by the year 2030. Such a depen
dency ratio would place considerable strain on the economy and
a larger burden on today's children-the next generation of work
ers. If the retirement age had risen at the same pace as life expec
tancy since the inception of Social Security in the mid-1930s, the
retirement age would be 76 today.
The second recommended change to Social Security is to index
the growth in future benefits (technically called the bend points
and the earnings history) to the consumer price index rather than
to wages. The benefit formula determines the starting cash benefit
level of each Social Security recipient. If that formula were indexed
to infation, future retirees would still receive increasing real bene
fits over time, but at a slower rate than currently projected. Real
benefits under the formula would double rather than triple over
the next 70 years. That change would gradually transform Social
Security benefits from a floor on relative benefits to a floor on real
benefts, protecting the poor but increasing the incentive of others
to save so as to have a higher level of retirement income.
Together, the two reforms would yield only minor savings of $5
billion to $10 billion by the year 2000. But the resulting savings
would be hundreds of billions of dollars by the third decade of
the next century. Both reforms are essential to avoiding the rapid
increase in Social Security tax rates that would otherwise be neces
sary to finance the system over the next 40 years. Implementing
the reforms early would give current workers a long time to adjust
to the changes.
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Balance the Budget
At some time, it would also be valuable to undertake a more
fundamental reform of Social Security. The next generation of work
ers will earn a very low rate of return from Social Security, with
or without the proposed reforms. Allowing workers to opt out of
the Social Security system in favor of a private pension plan or an
expanded IR would increase both the return on their savings and
the private savings rate. This proposal, however, would require
some general revenue money to finance Social Security benefits,
and the case for this reform depends on the amount by which the
additional savings would increase economic growth.
A Sequester and Freeze
The federal domestic budget has increased rapidly during the
past four years. Notwithstanding the rhetoric about savage Republi
can budget cuts, the real rate of growth of the domestic budget
since 1989 has been more than 7 percent per year-the fastest 4-
year expansion of the budget in 30 years. Some areas, such as
health care and social welfare spending, grew faster than others, but
every domestic program except agriculture shared in the domestic
spending build-up.
Clearly, the 1990 budget deal failed to restrain domestic expendi
tures. One reason for the failure is that all the spending reductions
were to occur in 1993, 1994, and 1995. Yet Congress is already
shying away from making those modest reductions. There is a good
chance that without a new budget strategy for the next four years,
Congress will choose to evade the budget ceilings of the 1990 budget
deal for 1994 and 1995 or shift savings from the military portion of
the budget to the domestic portion.
Domestic programs can and should be cut substantially in the
next four years, and reductions in domestic spending should take
effect soon. We believe that the most realistic way to achieve long
term spending restraint is for the new administration to adopt the
following strategy.
First, within the first 100 days, the new president should call for
an immediate 4 percent across-the-board spending reduction, or
sequester, effective in the second half of FY93. The sequester should
cover all programs in the domestic budget except Social Security.
The benefit levels of formula-payment programs would have to be
reduced by 4 percent. For discretionary programs the sequester
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would be carried out in much the same manner as the 1986 Gramm
Rudman sequester. The following benefits would be produced by
a sequester in the first 100 days of the new administration.
The sequester would reduce domestic expenditures by $14 billion
in FY93.
The sequester would permanently lower the baseline spending
levels for every domestic program other than Social Security.
Hence, the savings would multiply in every future year, thus
setting a solid foundation for balancing the budget by 1998.
The sequester would signal to the public, the Congress, and the
financial markets that the new president is serious about reducing
deficit spending during his administration.
Second, a ceiling on all domestic outlays (other than Social Secu
rity) should be established at the projected inflation rate of 3. 4
percent per year from FY94 through FY98. Congress would have
discretion in allocating funds among programs under the cap. For
the overall ceiling to be enforced, any excess spending in one year
would require a reduction of equal magnitude the next year. That
approach would have several benefits. First, since overall spending
would be allowed to increase at the rate of infation, the package
might be politically viable. Second, the overall cap would force
programs to compete with each other for funding. Congress would
be forced to curtail the growth of medical care and other formula
payment programs because, if those programs were allowed to
grow unimpeded, they would crowd out other domestic spending.
During the Gramm-Rudman era of 1986-89, when a similar cap
on expenditures existed, funding for formula-payment programs
increased at only 1 percent above inflation.
Many changes in current programs, of course, would be neces
sary to stay within the limits of the proposed freeze on real domestic
outlays. The remainder of this section describes the types of
changes to the medical programs and other domestic programs that
would be sufficient to implement a freeze.
Medical Care
For many years, the government has stimulated the demand and
restricted the supply of medical care. The consequence has been
rapid growth of both medical care prices and expenditures. In 1991,
for example, the relative price of medical care increased 5. 8 percent,
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and real per capita expenditures for medical care increased 5. 2
percent. The cost of health insurance is the most rapidly increasing
component of private payrolls. And payments for public medical
programs are the most rapidly growing component of government
budgets. The CBO forecasts that real federal expenditures for Medi
care and Medicaid will increase at a 7. 8 percent annual rate for
some years.
Our political system, however, appears ready to increase the prob
lem by broadening health insurance to the roughly 35 million
Americans who are now uninsured. President Bush endorsed a
combination of new tax credits and deductions for private health
insurance. Governor Clinton endorsed a proposal by congressional
Democrats for a "play or pay" system that would require all employ
ers to either provide health insurance or pay an additional 7 percent
payroll tax to finance a public plan. Either of those plans would
increase the demand for medical care, thereby augmenting current
pressures for an increase in medical care prices and expenditures.
Neither candidate proposed a credible plan to reduce the rapid
increase in medical prices and expenditures.
The current American system of financing and supplying medical
care cannot be sustained. Total expenditures for medical care have
increased from about 5 percent to 13 percent of GOP over the past
30 years. The primary reason for that increase is that the share of
health care costs paid directly by the patient has declined from
about 50 percent to about 20 percent during that period. Moreover,
the rapid increase in medical expenditures does not appear to have
had any significant effect on average health status and life expec
tancy. There are strong reasons to believe that the additional medi
cal services patients receive are not worth the additional costs.
Something must give. Given the dominance of third-party pay
ments, neither patients nor physicians have an adequate incentive
to control the costs of medical care. No claim on GOP can increase
indefinitely. And it is better to correct such unsustainable condi
tions sooner rather than later.
The demand for medical care will continue to increase in response
to an increase in real incomes and the relative size of the elderly
population. The primary focus of public policy should be on reduc
ing the growth of demand attributable to tax-subsidized private and
public health insurance. Any measure to broaden health insurance
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coverage to include those who would otherwise be uninsured
should be part of a more comprehensive plan to reduce the average
amount of tax-subsidized insurance and change the nature of that
insurance.
A substantial part of tax-subsidized health insurance accrues to
higher income people. Higher income people are more likely to be
privately insured, and the value of the tax deduction increases with
their marginal tax rate. Similarly, the people on Medicare who have
the highest incomes are likely to live the longest, and the value of
Medicare increases with their marginal tax rate. Clearly, the amount
of tax-subsidized health insurance could be substantially reduced
without much change in the insurance available to the poor.
It should be noted that the term "health insurance" is a double
misnomer. The event that is insured against is not some adverse
change in health status but the use of some type of medical care.
Moreover, most plans are not accurately described as insurance.
The basic concept of insurance is to reduce the variance of costs
among those with the same prior risks. Most plans, however,
include people with very different prior risks in the same premium
pool . Such plans are best described as medical prepayment plans
rather than health insurance. In effect, those plans redistribute
income from people who use few medical services to people who
use more medical services, regardless of the prior risks or income
of either group.
In summary, a reduction in tax-subsidized medical prepayment
plans is necessary to reduce the growth of demand for medical
care. That subsidy should be reduced primarily for higher income
people to ensure that they bear part of the burden of balancing the
budget. Tax-subsidized medical plans should be restructured as
indemnity insurance, like auto insurance. Patients would be paid
a fixed amount (above some deductible) per illness or accident but
would bear the full cost of any elective medical care. One or more of
the following measures should be considered as a way of achieving
those objectives .
Maintain the tax deduction only for "Medisave" types of indem
nity insurance. A full deduction for that type of insurance should
also be extended to purchasers of individual plans .
Limit or eliminate the tax deduction. A limit could be set at some
rate, such as $150 a month, that would be sufficient only for a
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high income-tested deductible. In either case, reduce the payroll
tax by a corresponding amount; elimination of the tax deduction,
for example, would permit a 2. 2-percentage-point reduction in
the payroll tax for all workers but have no net effect on federal
revenues .
Establish an income-tested deductible for the sum of payments
under Part A and Part B of Medicare. That deductible could, for
example, first be set at 1 . 5 percent of adjusted gross income (AGI)
in the prior year and then increased 1. 5 percentage points each
year for four years. Thus, beginning in the fifth year, the deduct
ible would be 7.5 percent of the prior year's AGI, the same rate
that is now in the individual income tax code. Payments above
the deductible, in most cases, would be fixed payments to the
patient per illness or accident. The plan should probably be aug
mented to pay for one visit to a physician a year to encourage
preventive care .
Establish a similar plan with a high income-tested deductible for
all Americans, including those who would otherwise be unin
sured. That comprehensive catastrophic health insurance plan
would replace the current tax deduction for private insurance
and the outlays for Medicare and Medicaid. The plan should
probably be augmented to pay for several visits to physicians
each year by pregnant women and infants.
In all cases, firms and individuals would be allowed to buy any
other amount and type of health insurance they desired, but only
with after-tax income.
Each of those measures would reduce the growth of the demand
for medical care, the relative inflation of the price of medical ser
vices, and total private and public expenditures for medical care.
The measures are listed in the order of increasing budget savings.
We have not estimated the specific budget savings attributable to
each measure, but even a Medisave plan would generate substantial
budget savings, without changing the federal insurance programs,
by reducing the relative increase in the price of medical care.
Any of the suggested measures would reduce the growth of
outlays for medical care by at least 1 percentage point a year, so a
$50 billion annual savings by FY98 could reasonably be expected.
Each of the measures would also reduce the pressure on state
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Medicaid budgets that has been caused by the rapid increase in
the relative price of medical care. Even with such savings, outlays
for medical care would increase at a steeper rate than those for
any other major federal program. More fundamental reforms will
someday prove necessary to stabilize total expenditures for medical
care as a share of GOP.
Other Progrms
Once a cap on federal expenditures is in place, the president will
need to set priorities for spending. There are hundreds of programs
in the federal budget that serve no general public interest and ought
to be terminated. Yet in the last four years, not a single program
was eliminated. Only a small handful of programs has been closed
down since 1980, despite a growing bipartisan consensus that tens
of billions of dollars in savings could be generated by such mea
sures.
What follows is a detailed list of 50 program terminations and
reforms that would yield the savings needed to produce a balanced
budget by 1998. We have chosen these budget reductions not only
because they are all advisable on policy grounds, but because we
believe that they may be politically achievable. For instance, most
of the budget changes we list have been recommended in full or
in part by House Budget Committee Chairman Leon Panetta. Oth
ers have been suggested by nonpartisan groups, such as the Con
gressional Budget Office and the General Accounting Office. Table
4. 2, which appears at the end of this section, is our proposed list
of discretionary budget changes. It notes which of those budget
cuts have been recommended by the CBO or the House Budget
Committee. Each recommendation would save at least $1 billion
by 1998.
1 . End additional U. S. fnancial support for the International Monetary
Fund (lMF) and the World Bank. The mission of the IMF and the
World Bank is to promote development of less developed countries.
After tens of billions of dollars of U. S. investment in those multilat
eral organizations, there is no evidence that they have had any
success in promoting growth in the countries they supposedly are
assisting with their lending programs. Often, they give countries
precisely the wrong advice, as when they urge tax increases to
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balance the budget or provide funding for government public works
projects.
2. End U. S. foreign aid to Israel and Egypt. Israel and Egypt each
receive more than $1 billion in U. S. taxpayer support each year.
Considering the huge military budgets of those two nations and
the elimination of the Soviet threat in the Middle East, the case for
massive U. s. assistance has been substantially reduced. The United
States can and should assist the economies of those countries
through free-trade arrangements with both.
3. Eliminate U. S. fnding of the Agency for International Development
(AID) and the Export-Import Bank. Development economist Peter T.
Bauer of the London School of Economics has written that the
major impact of U. S. international aid programs has been to reward
wasteful and irresponsible economic policies in less developed
countries. Bauer has found that AID funds do not regularly encour
age free enterprise, free markets, and local entrepreneurship. But
those three things are the essential keys to development. Since
there is no evidence that AID promotes development, it should be
closed down. Similarly, the Export-Import Bank subsidizes exports
of major U. S. firms, including Boeing Co. , General Electric Co. ,
and Westinghouse Electric Co. A report by the Federal Reserve
Bank of Minneapolis concludes that the bank's subsidy program
"does not offset other nations' [trade] distortions; it adds to them. "
4. Cancel the super collider and the space station. The super collider
is quickly becoming one of the most expensive public works projects
in U. S. history. Increasingly, the scientific community is question
ing the collider's scientific importance, and its supporters cannot
justify its multi-billion-dollar price tag. Every year the cost estimates
for the project have risen-from an original estimate of $6 billion
in 1987 to $11 billion today. Similarly, the scientific benefits of the
space station's manned missions to the moon and Mars are not
expected to come close to matching its $10-billion-plus five-year
price tag. The space station has come under criticism from
the CBO, the National Research Institute, the Office of Technol
ogy Assessment, and many private research groups. It should be
scuttled.
5. End Bureau of Reclamation water projects. The Bureau of Reclama
tion was formed in 1902 to promote the economic development of
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the arid West. After 90 years that mission has been accomplished
all too often to the detriment of the environment. There are very
few free-flowing rivers left in the West, thanks to the bureau's
agricultural irrigation projects. John Baden of the Foundation for
Research on the Environment and the Economy says that the gov
ernment's below-market pricing of bureau water fostered huge inef
ficiencies in the use of scarce water resources in California and
other states.
6. End any net federal land acquisition. The federal government
owns more than one-quarter of all the land in the United States.
Yet each year the Department of the Interior's National Park Service
and Bureau of Land and Mineral Management and the Department
of Agriculture (Forest Service and other agencies) spend roughly
$1 billion buying tens of thousands of additional acres. Well over
half of the government's land holdings have no environmental or
recreational significance. Massive government land holdings are
inconsistent with a nation founded on the premises of free enter
prise and respect for private property. The new president should
place an immediate moratorium on any net increases in government
land holdings and require an orderly auctioning of federally owned
land that does not serve any national interest.
7. End all U. S. Department of Agriculture conservation programs. U. S.
farmers are far and away the most productive and enterprising in
the world. They do not need the federal government's encourage
ment or subsidies to safeguard the value of their most important
asset: their land and soil. Yet each year the federal government
spends roughly $1 . 5 billion to pay farmers to remove erodible land
from production. Cato Institute adjunct scholar James Bovard has
found that in some cases the taxpayer reimburses farmers as much
as three times the rental value of their land if they participate
in government conservation programs. The real agenda of those
programs is to provide yet another subsidy to farmers, not to pro
mote sound resource management.
8. Terminate all federal wastewater treatment subsidies. For the past
20 years the federal government has provided grants and loans to
local governments to build wastewater treatment facilities to com
ply with federal clean water statutes. The provision of federal mon
eys has had two perverse effects. First, the CBO reports that federal
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support has often kept cities from building such facilities on their
own, because they prefer to wait for federal money, even while
their wastewater is violating clean water standards. Second, the
program has shifted the burden of paying for water cleanup from
local polluters to federal taxpayers. Such subsidies thus encourage
more pollution, not less.
9. Phase out all agriculture crop subsidies over fve years. In the 1980s
farm subsidies were the fastest growth area in the entire budget
they grew at an even faster pace than Reagan's defense build
up. The U. S. Department of Agriculture budget ballooned from $
billion in 1980 to $21 billion in 1989. Those funds subsidize produc
tion of a whole range of commodities: cotton, wheat, wool, and
corn. Most Americans continue to believe the popular folklore that
crop subsidies benefit struggling family farmers. In fact, most of
the money subsidizes huge million-dollar-plus agribusinesses. The
USDA concedes that two-thirds of the payments are made to the
richest 15 percent of U. S. farmers. Moreover, the net worth of the
average farmer today is twice as great as that of the average U. S.
family, and the farmer's income is, on average, 25 percent higher.
Federal supports are such a vital element of farm incomes today
that it has become a truism that many farmers now produce for
the government, not the market. All major crop subsidy programs
should be reduced by 20 percent per year through 1998 and then
permanently canceled.
10. End federal dair subsidies. Since 1980 dairy subsidies-which
artificially raise the price of milk, cheese, butter, and other prod
ucts-have cost U. S. consumers an estimated $40 billion. Mean
while, the federal government has spent $17 billion purchasing
excess dairy products-many of which eventually rot in massive
government warehouses. The Office of Technology Assessment
estimates that because of new technologies and increased produc
tivity, by the end of the century there could be as few as 5,000
commercial dairy farmers left in the United States. If the current
program is not ended, taxpayers will soon be providing over
$200,000 in support for each dairy producer in order to pay higher
prices for dairy products at the store.
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1 1 . End the Export Enhancement Program, the Market Promotion Pro
gram, the Agriculture Extension Seroice, and other obsolete USDA pro
grams. Both the Export Enhancement Program and the Market Pro
motion Program are intended to increase U. S. agricultural exports.
In practice they are simply a taxpayer subsidy to foreign purchasers
of U. S. agricultural products. Moreover, most of the U. S. compa
nies that have benefited from those programs are in no need of
federal support. They include McDonald's, Pillsbury, Sunkist, and
the Ernest and Julio Gallo Winery. Rep. Charles Schumer calls those
programs "corporate welfare. " The Agricultural Extension Service
was formed in 1914 to provide technical farming assistance at a
time when more than a third of all Americans lived on farms. Today
only 2 percent of Americans are farmers, yet few of the AES's 3, 000
field offces have been closed. The agency now provides courses
in such vital fields as home economics, urban gardening, sewing,
and gourmet cooking.
12. Reform Farmers Home Administration (FmHA) lending policies.
The FmHA administers an array of direct and guaranteed loan
programs for housing low-income families in rural areas. It has a
woefully poor lending record, even for a government agency, with
accumulated losses estimated at $60 billion by the GAO. The delin
quency rates on several FmHA loan programs are over 40 percent.
Meanwhile, the program continues to encourage further home
building in rural areas even though the problem in most rural areas
is a surplus, not a shortage, of housing. All FmHA housing lending
should be immediately terminated. The FmHA's fast-growing
inventory of defaulted properties should be sold. Very poor rural
residents in need of housing assistance should be served through
a housing voucher program.
13. End all Rural Electrifcation Administration (REA) lending and
subsidies. The REA is the federal government's ultimate anachro
nism. It was created in 1935 to bring electricity and telephone service
to rural America, and its mission has been accomplished. More
than 98 percent of all rural homes now have access to electrical and
phone service. Yet the agency continues to loan over $2 billion at
subsidized rates to rural electric co-ops each year. The Treasury is
now owed over $8 billion in those low-cost loans. This costly sub
sidy continues only because of the political clout of the rural electric
cooperatives.
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14. Terminate Community Development Block Grants (CDBGs), the
Economic Development Administration (EDA), and the Appalachian
Regional Commission (ARC) . After 25 years, federal community
development grants and loans have had little success in promoting
urban renewal. Gary, Indiana, for example, has received more than
$1,000 per resident in federal aid to build a convention center and
other new municipal facilities, yet the area continues to lose people
and businesses. CDBGs and the EDA were supposed to help only
distressed areas, but both have been criticized by the CBO for
increasingly funneling money to wealthier and more politically
powerful areas. The ARC has spent almost $6 billion and built some
2,500 miles of new roads, yet high poverty rates still persist in
Appalachia. The federal government should get out of the business
of providing funding for local programs. With few exceptions, the
cost of local government activities should be borne entirely by local
taxpayers.
15. End Social Security Block Grants (SSBGs), Community Service
Block Grants (CSBGs), and Title X Family Planning Grants. The CSBG
and SSBG programs are offshoots of President Lyndon Johnson'S
War on Poverty. They fund a wide range of job-training, employ
ment, health, energy, and child-care services, virtually all of which
are local and state responsibilities and should be funded by those
entities, if at all . The primary beneficiary of the funds has been a
huge and politically influential human services industry. It not
only lobbies for additional funding, it also helps create regulatory
barriers, such as licensing or certification requirements for day care
and many forms of anti-poverty assistance, that lock out much
less costly alternatives for human service delivery. After 20 years,
several studies have shown that Title X family planning grants have
had no success in reducing unintended pregnancies. An estimated
$50 million of those grants goes to a handful of groups, including
the National Family Planning and Reproductive Health Association
and Planned Parenthood of America, which could certainly raise
the funds they need privately.
1 6. Eliminate the Small Business Administration. The best way for
the federal government to help U. S. small businesses is to cut
wasteful spending and the excessive taxes that pay for it. The SBA
loan programs assist less than 0.5 percent of all small businesses.
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To qualify for an SBA loan a business must have been turned down
for a loan by at least two banks. Not surprisingly, the SBA has a
terrible record in selecting businesses to support-as many as 20
percent of its loans go sour in any given year. The SBA does not,
of course, create an additional pool of capital for small businesses;
rather, it redirects capital from enterprises that are likely to succeed
to enterprises that are likely to fail .
1 7. Terminate all earmarked highway demonstration projects. The 1991
highway bill contained $5 billion for "highway demonstration proj
ects" -or almost one pork-barrel project for every congressional
district. The sole purpose of those projects is to get members of
Congress reelected. Recent projects include a parking garage in
Chicago to "demonstrate" that parking facilities reduce on-street
parking problems, a new road in rural West Virginia to reduce
congestion, and a highway access ramp to an amusement park in
Toledo, Ohio. Those projects violate an 80-year-old congressional
rule that highway bills should never fund any specific road. Deci
sions about road building are supposed to be made by the individual
states. The new Congress should wipe the slate clean by defunding
every one of those costly and indefensible proj ects.
18. End subsidies for urban mass transit. Since 1965 the federal
government has spent nearly $50 billion on urban mass transit, yet
ridership has actually declined since then. The 1990 census revealed
that in virtually every city that built an expensive new rail project
in the 1980s with federal support, mass transit had a declining
share of the commuter market. Two prominent examples of costly
failures are Miami's Metrorail, which cost federal taxpayers more
than $1 billion to build but carries only 15 percent of the projected
ridership and is losing over $100 million a year, and Detroit's People
Mover, which received $200 million in construction funding from
Washington and yet is almost bankrupt today because of low rider
ship. In the mid-1980s then-senator William Proxmire gave urban
transit subsidies his Golden Fleece Award because, as he said, they
had proven to be a "spectacular flop" and served no purpose other
than "playing Santa Claus to America's cities. " The program is no
better today.
1 9. Terminate federal airport grants. The federal government should
not be subsidizing airline travel . More than 3, 000 airports receive
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federal assistance each year. That assistance comes primarily from
the airline ticket tax. Most of the assisted airports are in small cities,
and the major beneficiaries are owners of small private planes
hardly a financially stressed class of citizens. The grants should
cease, and airports that cannot survive without taxpayer subsidies
should be closed or privatized.
20. Reduce Amtrak subsidies b 20 percent per year and privatize the
railroad in 1 998. The federal government should not be in the busi
ness of running a railroad. Federal subsidies to Amtrak average
roughly $25 per passenger. Train travel is 20 to 100 times more
heavily subsidized on a per-passenger-mile basis than is travel by
automobile, bus, or air. When bankrupt passenger lines were taken
over by the federal government in 197, the newly created Amtrak
was supposed to receive a temporary infusion of federal funds and
then be moved back to private ownership. Now 20 years later it is
not only still federally subsidized, it is requesting a multi-billion
dollar infusion of additional federal money to cover capital
expenses. That request for funds should be declined, and Amtrak
should be given five years to reduce its costs-by renegotiating
outmoded labor rules, shedding money-losing routes, improving
marketing plans, and raising ticket prices. Then the railroad should
be auctioned off in full or in part.
21 . Reform the student loan program to minimize taxpayer losses. The
federal student loan program has quickly mushroomed into one of
the federal government's largest middle- and upper-income sub
sidy programs. College loans are now available to virtually all stu
dents. That explains the program's broad base of support. Today
students can receive loans for going to bartending school or for
learning hairdressing and cosmetology. The program is taxpayer
subsidized because the federal government offers below-market
interest rates and does not fully charge for the risks of nonpayment.
Default rates on student loans are typically 10 to 15 percent, and the
current portfolio of bad loans exceeds $11. 5 billion and is mounting.
Those losses can be minimized in the future by ( 1) charging market
interest rates on student loans once the student leaves or finishes
school, (2) reducing federal payments to lenders by one-quarter of
a percentage point, and (3) refusing high school dropouts student
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loans. To reduce future demand for the program and place financ
ing responsibilities back on the shoulders of families, a new tax
free college savings account should be established by the federal
government.
22. Cut elementary and secondary education funding b 50 percent.
The problem with America's schools is not that they are under
funded. In constant 1990 dollars, the schools spent roughly $1, 500
per student in 1950, $3,000 per student in 1970, and $6,000 per
student in 1990. Moreover, the federal share of elementary and
secondary school funding is much larger today than it was in 1950
when the schools were much better. Schools have had to subject
themselves to more federal guidelines and regulations while sacri
ficing local autonomy. Federal funding for elementary and second
ary education should be cut in half, and the remaining funds should
be rechanneled to low-income parents in the form of vouchers.
School choice is the reform that offers the most hope for innovation
and increased productivity in the schools. Federal aid currently
inhibits rather than encourages change.
23. End funding for the National Endowment for the Humanities (NEH),
the National Endowment for the Arts (NEA), and the Corporation for
Public Broadcasting (CPB). Art and culture play an important role in
society, but that is not an argument for government financing of
such activities. Most programs of the type funded by the NEH, the
NEA, and the CPB should and would be financed entirely with
private money. The clientele for each of those programs tends to
be the affluent, who can afford to pay for the art and culture they
want. The highly controversial nature of much of the programming
and the projects that receive funding, such as the Mapplethorpe
exhibit financed by the NEA, is a further argument for withdrawing
taxpayer money.
24. Terminate Impact Aid Part B. Impact Aid compensates local
governments for the ostensible cost of educating the children of
military employees. Impact Aid Part B is a payment to local districts
for the 1 . 5 million children of parents who work on military bases
but do not live there. Those families already pay state and local
taxes; hence Impact Aid is not needed. Impact Aid is based on the
erroneous premise that military bases are a cost for local communi
ties. Yet the current fierce resistance to closures of even highly
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obsolete bases demonstrates the value of those bases to local com
munities. When Hurricane Andrew wiped out Homestead Air
Force Base in Florida that was supposed to be closed, the commu
nity lobbied successfully to have it rebuilt. Given the benefits local
communities derive from the jobs and infusion of funds associated
with military bases, there is no reason to provide additional dollars
through Impact Aid.
25. Reduce National Institute of Health (NIH) subsidies for overhead
expenses. Reports by both the GAO and the CBO have faulted the
NIH for reimbursing universities, hospitals, and other outside insti
tutions for excessive overhead expenditures. More than 30 percent
of NIH grants pay for costs not directly associated with the research
being funded. The recent Defense Department contract scandals
at Stanford University have brought to the public's attention the
problem of universities' overcharging for indirect expenses. Now
over 250 schools are under investigation by the NIH. Cutting indi
rect cost reimbursement by 20 percent would not sacrifice valuable
biomedical research, but it would give institutions a greater incen
tive to control costs.
26. Reform the Federal Housing Administration (FHA) mortgage guar
antee program. Next to Social Security, the FHA, which insures
mortgages on single-family and multifamily homes, is perhaps the
largest middle-income subsidy program in the federal budget. The
FHA now controls roughly 55 percent of the mortgage insurance
business, because of its attractive subsidies to hore buyers. In
recent years those subsidies have forced federal taxpayers to swal
low billions of dollars in losses on defaulted mortgages. During the
Depression, the FHA was the only available mortgage insurer.
Today there are many private mortgage insurance alternatives to
the FHA. To reduce its future losses and to pave the way to a
gradual exit from the market, the FHA should (1) require a 10
percent down payment on all loans and (2) discontinue insurance
of refinanced loans, purchases of second homes, and investment
properties.
27. Eliminate the Job Corps, the Job Training Partnership Act (fTPA),
and Trade Adjustment Assistance (T AA). Federal job-training pro
grams for youth and retraining programs for adults have a long
history of failure. For example, it costs the Job Corps about $30,000
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per client, or roughly what it would cost to send those youngsters
to Harvard. The JTPA has a very poor record of successfully training
and placing its clients in good-paying jobs. Years of experience
indicate that the best job training is on-the-job training. The Job
Corps and JTP A often delay workers' entry or reentry into the labor
force. The TAA gives workers displaced from their jobs because of
foreign competition up to 78 weeks of paid benefits. Yet there is
no reason why workers who lose their jobs as a result of foreign
competition should be entitled to a longer period of government
assistance than workers displaced for other reasons. The T AA
should be abolished and replaced by the normal unemployment
insurance program.
28. Repeal the Davis-Bacon Act. The 1931 Davis-Bacon Act requires
construction contractors to pay their workers at least the "prevailing
wage" on all federal construction contracts. In practice the prevail
ing wage has become the union wage. It inflates the cost of all the
tens of billions of dollars of federal construction contracts by an
estimated 30 percent. Moreover, the purpose of the act was ' to
keep blacks and immigrants from competing with white unionized
workers on federal construction contracts. Today it continues to
have that effect. Hence, the law is discriminatory not only in intent
but in practice. The CBO, the GAO, the Grace Commission, and
many other independent groups have called for the repeal of Davis
Bacon. Repealing it would save at least $2 billion per year.
29. Repeal the Service Contract Act, all minority set-aside programs,
and Buy America provisions that raise the cost of federal contracts. The
Service Contract Act is the counterpart of Davis-Bacon for all federal
service contracts. Its prevailing wage requirements, which limit
competition from low-cost contractors, inflate the cost of federal
contracts by roughly $1 billion per year. Minority contract set-asides
are a form of affirmative action for federal contractors. Set-asides
discriminate against nonminorities and add about 10 percent to the
costs of federal contracts. Buy America provisions require contrac
tors to use U. S. -made parts on selected contracts, even when lower
cost, higher quality imports are available. That form of protection
ism does not serve the interests of U. S. taxpayers, just as protection
ism generally ill-serves U. S. consumers.
30. Cut all agency overhead by 2 percent. The federal workforce grew
by 100, 000 workers between 1984 and 1992. The federal budget
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grew by 30 percent in real terms from 1989 to 1992. A 2 percent
across-the-board reduction in overhead costs should be easily
achievable without sacrificing government services. Most busi
nesses and households cut their budgets by at least that amount
during the 1990-91 recession.
31 . Cut federal pay b 10 percent. A 1988 Office of Personnel Man
agement report found that the voluntary quit rate in the federal
government was lower than it was in the private sector during the
Great Depression. Moreover, there is a huge queue of qualified
workers waiting to become federal employees. In recent years the
wages of federal blue-collar employees have been rising faster than
those of private-sector employees. Those statistics suggest that the
federal government could significantly reduce wages without sacri
ficing service quality or productivity.
32. Auction of the electromagnetic spectrum. The Federal Communi
cations Commission has the authority to license and regulate unas
signed frequencies on the electromagnetic spectrum. Currently,
those frequencies are assigned through a lottery system. That con
fers a huge windfall on the winning applicant, who often turns
around and sells the frequency rights for a large profit. An auction
ing system would be more economically efficient and would reduce
the national debt by about $3. 5 billion.
33. Lease the Arctic National Wildlife Refuge (ANWR) . According
to U. S. geologists, ANWR probably contains more oil than any
remaining onshore area of the United States. In 1987 the U. S.
Department of the Interior estimated that the net benefit to the
U. S. economy of developing ANWR could approach $80 billion.
Extreme environmentalists have prevented its exploitation, even
though the area that would be developed would be only a tiny
fraction of that vast uninhabited wilderness. If a portion of the
revenues raised from ANWR's development were used to create a
national wildlife trust fund, the environmental objections to drilling
could be surmounted.
34. End all Power Marketing Administration subsidies. The federal
government generates electric power at 127 federal dars under
the authority of five Power Marketing Administrations (PMAs).
The PMAs charge below-market rates for electricity. The subsidies
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cost the federal government roughly $1 . 5 billion annually. Under
priced federal electricity powers affluent neighborhoods and even
gambling casinos in Las Vegas. Ideally, the PMAs should simply
be privatized and operated- as for-profit businesses. If Congress
will not allow that, it should at least end the inefficient and costly
subsidies to the PMAs.
35. Cut congressional and White House staf and expenses b 33 percent.
George Bush suggested this reform in the 1992 presidential cam
paign. Since the early 1960s the overall size of the congressional
staff has roughly tripled. Committee staffing has grown even faster.
In real dollars, the cost of running Congress today ($2. 8 billion) is
2. 5 times what it was in the mid-1960s. Members of Congress make
$130,000 salaries, and more than 350 staffers make at least $100,000.
White House salaries often run even higher. Belt tightening in the
legislative and executive branches would result in better and less
intrusive government.
36. Reduce the U. S. Department of Commerce budget by 50 percent.
Other than the functions of the U. S. Census Bureau, almost none of
the activities of the Department of Commerce serve any overriding
national interest. Many of its activities revolve around trade promo
tion, regulation of trade, and economic development. Not only are
those inappropriate activities for government, but the Commerce
Department has not proven effective in carrying them out. The
new president should undertake a comprehensive review of all the
agencies of the Commerce Department and terminate those that
are not inherently governmental in nature.
37. Eliminate the U. S. Department of Energy. The U. S. Department
of Energy was created by Jimmy Carter in 1977 during the height
of the oil crisis. Over the years, the price controls and subsidies of
the DOE have cost U. S. taxpayers, consumers, and industry tens
of billions of dollars. The length and severity of the oil crisis of
the 1970s were directly attributable to the regulatory apparatus
of DOE-namely, oil price controls. Other projects, such as the
Synfuels Corporation, were multi-billion-dollar flops that never
produced a kilowatt of electricity. The lesson of the 1970s and 1980s
is that energy markets serve consumers and industry best when
the free market is permitted to operate. Finally, about half of the
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DOE's budget is dedicated to nuclear weapons testing and experi
mentation. The end of the Cold War has reduced the urgency of
such programs. Those that are still vital to national security should
be shifted to the Defense Department.
38. End Veterans' Administration health care benefts for non-service
related injuries and illnesses. The original purpose of veterans' medical
benefits was to treat combat-related injuries and other illnesses
sustained during the time of service. That is an appropriate govern
ment compact with the men and women who served in the military.
But those health benefits have been expanded to cover impover
ished and sick veterans, whose affictions have no connection with
their military service. The CBO reports that in 1987 almost 80 per
cent of Veterans' Administration health care, including 1. 3 million
hospital stays and 19 million doctor visits, went for non-service
related medical problems. Those veterans should be covered by
other public programs or by private health insurance.
39. Cut regulatory agency budgets by 25 percent. Federal regulations
grew at a rapid pace in the period 1989-93, reversing the anti
regulation policies of Ronald Reagan. At the same time, the budgets
of all regulatory agencies grew at twice the inflation rate. That
period proved that more money and more regulators lead to more
stifling regulation. A 25 percent reduction in the total budgets of
regulatory agencies would help eliminate unnecessary and capri
cious regulation and force agency personnel to concentrate their
resources on their highest priorities. That would unshackle busi
ness from frivolous regulatory burdens that have contributed
directly to the current very sluggish economic growth.
Reducing Federal Entitlement Spending
It is virtually impossible to balance the budget without signifi
cantly curtailing spending on what have become known as entitle
ment programs. Entitlement programs automatically provide cash
or benefits to individuals who meet the eligibility criteria. The major
categories of entitlements are retirement benefits, health care, and
welfare. From 1989 to 1992 real entitlement spending increased by
$115 billion to $600 billion-a 23 percent increase over inflation. In
addition to the health care and Social Security reforms mentioned
above, we propose the following spending reductions.
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40. Require the states to pay a minimum of 50 perce1t of the costs of
Food Stamps, Aid to Families with Dependent Children (AFDC), and
Medicaid. States are beginning to aggressively experiment with cost
reduction reforms in welfare and health care. The most ambitious
of those experiments, designed to get people off welfare in a hurry,
have been adopted in Wisconsin under Gov. Tommy Thompson.
Unfortunately, cost cutting is often discouraged by the current
federal reimbursement scheme, because any welfare or Medicaid
expense reduction means smaller checks from the federal govern
ment. One method of spurring innovation in welfare and govern
ment health care insurance is to force all states to pay at least half
the cost of the Food Stamps, AFDC, and Medicaid programs. That
measure should be combined with a substantial reduction in the
federal mandates so as to allow state governments increased flexi
bility to structure the supply of welfare services. Eventually, all
government low-income programs should be financed by the states
and localities.
41 . End militar cost-of-living adjustments for veterans retiring before
age 62. Neither Social Security nor most private pension programs
offer retirement benefits before the age of 62. Yet it is not unusual
for members of the armed forces to retire in their 50s. Simply ending
cost-of-bving adjustments to the pensions of military personnel
who retire before the age of 62 would save at least $2. 5 billion per
year.
42. End the lump-sum Civil Service Retirement System (CSRS) option
and require federal workers to cover a larger share of the cost of the CSRS
system. The unfunded liability of the CSRS has already exceeded
$1 trillion, and the amount is growing larger each year. Because
many civil servants are also eligible for Social Security, it is not
uncommon for a federal retiree to receive two government pensions
worth more than $75,000 per year. The excessive benefits offered
under the CSRS program should be curtailed by ( 1) eliminating the
lump-sum retirement option, which allows retirees to withdraw
lump-sum payments from CSRS equal to the total of their own
contributions to the system; (2) increasing the federal retirement
age from 55 to 65; and (3) applying a means test to those retirees
who are eligible for both CSRS and Social Security.
43. Replace AFDC, Food Stamps, public housing assistance, the earned
income tax credit (EIrC), and other welfare programs with a cash assistance
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Balance the Budget
program requiring work. The federal government, along with the
states and cities, spends an estimated $180 billion per year on anti
poverty programs. That is almost two and a half times the $75
billion that would be needed to lift every family now below the
poverty level to above the poverty level. But the poverty rate in
the United States is still extremely high. One reason is that a large
portion of anti-poverty spending is captured by welfare bureaucra
cies and service providers. Milwaukee, Wisconsin, for example,
has more than 70 separate welfare assistance programs. America's
current fragmented system of welfare delivery serves no one but
a large and growing welfare industry. AFDC, public housing, Food
Stamps, the EITC, and other welfare programs should be merged
into a single welfare cash assistance program. The program should
have a spending ceiling of 70 percent of the current welfare pro
grams folded into it. All employable recipients should be required
to work in exchange for their monthly checks.
4. Eliminate Food Stamps, public housing, and other welfare benefts
for all able-bodied adults. Many states, including Michigan and Massa
chusetts, have begun to eliminate public assistance for employable
adults-a category they have tended to define as those without
disabilities or young children at home. Yet many federal programs,
including, most prominently, the Food Stamp program, offer bene
fits to low-income Americans even if they are fully capable of work
ing. Today, for example, roughly 24 million people-or 1 of every
10 Americans-receives Food Stamps. The vast majority of those
recipients are able to work. This category of federal public assistance
should be ended.
45. Sharply reduce unemployment insurance benefts and delay benefts
for one month. Studies have shown that roughly one-third of all
unemployment in the United States is a result of the federal govern
ment's perverse unemployment insurance system. It rewards those
who become unemployed for staying unemployed. Yet in the past
two years Congress has made the unemployment insurance system
far more rewarding by extending benefits from 26 weeks to 52
weeks or more. Almost all unemployment insurance claimants are
able-bodied employable adults. Benefits should be delayed for one
month upon layoff or firing and reduced by 5 percent per week
for 20 weeks.
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46. End all federal child-care subsidies. Only in the past few years
has anyone thought of child care, which was once called baby
sitting, as a federal responsibility. Yet today the federal government
spends roughly $3 billion annually on payments to government
child-care centers and subsidies to parents who place their children
in private child-care facilities. That means that families with two
parents working and a child in day care receive a federal subsidy
paid for in part by parents who make the financial sacrifice of
having only one parent work and the other take care of the child
at home. Financing child care, regardless of the type families
choose, is the proper responsibility of parents, not taxpayers.
47. Reduce Head Start funding by 50 percent. The budget for Head
Start has climbed by two-thirds since 1989-after adjusting for
inflation. Although Head Start is one of Washington bureaucrats'
most popular programs, the evidence of its success is mixed, at
best. Several studies document that Head Start does offer children
a head start, but that their lead over non-Head Start children dissi
pates after several years in school. The most negative impact of
Head Start is that it has created a huge and expanding preschool
bureaucracy.
48. End all new construction of public housing. Even many advocates
of public housing now concede that the huge public housing proj
ects built in the 1960s and 1970s were an expensive mistake. Public
housing projects became unlivable centers of crime, drugs, teen
pregnancy, juvenile delinquency, and a vicious cycle of poverty.
Yet under George Bush from 1989 to 1992, new public housing
starts accelerated. In almost all areas of the country today, the low
income housing problem is one of lack of affordability, not lack of
availability. And the short supply of low-income housing in some
cities is a result of counterproductive government housing policies,
such as rent control, building code regulations, and exclusionary
zoning. Rather than build more public housing units, the federal
government should combat poliCies that reduce the housing oppor
tunities of the poor.
49. Target all children's nutrition subsidies to families with incomes
below the poverty level. The federal government spends $800 million
each year on school lunches, breakfasts, and other nutrition subsid
ies for children of families that are middle class, not poor. In 1988
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subsidized meals at home day-care centers cost $250 million a
year-and 70 percent of the children come from families with
incomes over $30,000. A strong case could be made for abolishing
the feeding subsidies entirely; if they continue, they should provide
assistance only to children from families under the poverty line.
50. End low-income home energy assistance. The low-income home
energy assistance program was created in the 1970s during the
energy crisis to provide subsidies for home heating to low-income
families. The energy crisis ended a decade ago. Home heating costs
are now at about their pre-OPEC levels. Since the crisis has ended,
so should the subsidies.
Table 4. 2 summarizes the proposed program changes and the
estimated savings specific to each measure. The sum of the pro
posed spending cuts would reduce total spending by about $120
billion relative to the level now projected for FY98.
A final note: We do not necessarily endorse any federal program
by its omission from this list. The current federal budget share of
GOP is about 10 times what it was in 1929, and many of the new
programs added since then merit reconsideration. Our budget plan
would reduce federal outlays from 25 percent of GOP in 1992 to
about 19 percent by 1997. We invite readers to identify their own
least favorite programs to add to our list.
Table 4. 2
RECOMMENDED DOMESTIC BUDGET CUTS
(BILLIONS OF DOLLARS)
1994 1998 Panetta CBO
Discretionary programs
End participation in
IMF and W orId Bank
End aid to Israel
and Egypt
Cancel super collider
and space station
End Bureau of Recla
mation water projects
0. 5
0. 2
1. 5
1 . 3
1. 0
1 . 5 X
3. 5 X X
2. 0
(Continued on next page)
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Table 4. 2-Continued
RECOMMENDED DOMESTIC BUDGET CUTS
(BILLIONS OF DOLLARS)
1994 1998 Panetta CBO
End all federal
land acquisition 1 . 0 1 . 0 X
End agricultural
conservation
programs 0. 2 1 . 0
End wastewater
treatment subsidies 0. 1 2. 0 X X
Phase out crop
subsidies 3. 0 6. 5 X
End dairy
subsidies 0. 5 1 . 0
End miscellaneous
agricultural
programs 1 . 0 1 . 0 X
Terminate SBA 0. 2 2. 0 X
Cancel highway
demonstrations 0. 6 1. 5 X
End transit subsidies 1. 3 2. 0 X X
Terminate airport
grants 0. 3 2. 0 X X
Terminate community
development grants 0. 8 1 . 0
Phase out all
Amtrak subsidies 0. 1 1. 0 X
Reform FmHA lending 0. 6 1. 5 X X
Reform student loan
program 1 . 0 2. 0 X
Cut elementary and
secondary edu-
cation funding 3. 5 5. 0
End NEAlNEHlCPB 1 . 0 1 . 0
Cut NIH subsidies
for overhead 1 . 2 1. 5 X X
End SSBG/CSBG 0. 4 2. 0
Repeal Davis-Bacon 1 . 0 2. 5 X
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Balance the Budget
Table 4. 2-Continued
RECOMMENDED DOMESTIC BUDGET CUTS
(BILLIONS OF DOLLARS)
1994 1998 Panetta CBO
Repeal Service Contract Act 1. 0 2. 0
End Impact Aid 0. 4 1. 0 x
Cut agency overhead 2% 0. 6 6. 0 x
Cut AID and Export-Import
Bank 0. 3 2. 0 x
Auction spectrum 0. 0 1. 0 x x
Eliminate Department
of Energy 1. 5 6. 5
Reform veterans'
health care 0. 5 2. 5 x
Lease ANWR 0. 1 1 . 5
Reform FHA
lending policies 1 . 0 1 . 0
Cut federal pay 10% 1 . 0 1 . 0
Reform REA 0. 1 1. 0 x
Cut Job CorpslJTP A
TAA 50% 0. 2 1. 5
End power marketing
subsidies 0. 1 1. 0 x
Cut congressionaV
White House budgets 0. 2 1 . 0
Cut Dept. of Commerce
budget 50% 0. 2 1. 5
Cut regulatory agency
budgets 0. 2 1. 5
Total 28. 5 79. 0
Entitlement reforms
Require states to pay
50% match 0. 6 4. 0 x x
End miliary COLAs at
age 62 0. 3 2. 5 x x
Reduce CSRS
benefits 0. 3 4. 5 x x
(Continued on next page)
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Table 4. 2-Continued
RECOMMENDED DOMESTIC BUDGET CUTS
(BILLIONS OF DOLLARS)
1994 1998 Panetta CBO
Consolidate welfare
programs 1. 5 10. 0
End welfare benefits
for able-bodied 1. 5 6. 0
Reduce unemployment
insurance benefits 1. 5 5. 0
End day-care subsidies 0. 2 3. 0 x
Reduce Head Start funding 0. 5 2. 0
End new public housing
construction 1. 5 3. 5 x
Target children's nutrition 0. 3 1 . 0 x x
End low-income home
energy assistance 0. 2 1 . 0 x
Total 8. 4 42. 5
Total Savings and the Budget
The sum of the measures described above would be sufficient to
balance the budget by FY98 with no increase in taxes. Table 4. 3
summarizes those savings by major category.
The defense budget would bear the largest proportional cuts. The
many domestic programs other than Social Security and medical
insurance would bear the largest absolute cuts.
Table 4. 3
PROPOSED BUDGET SAVINGS (BILLIONS OF DOLLARS)
Fiscal Year
93 94 95 96 97 98
Defense 0 16 41 61 81 101
Social Security 0 0 1 2 3 4
Medical 0 1 7 18 30 50
Other 14 35 41 58 72 118
Net interest 0 2 8 16 30 49
Total 14 54 98 155 216 322
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Balance the Budget
Table 4. 4
THE PATH TO A BALANCED BUDGET (BILLIONS OF DOLLARS)
Fiscal Year
93 94 95 96 97 98
Outlays
Defense 297 268 243 226 209 192
Social Security 302 318 335 352 371 390
Medical 226 250 273 296 319 339
Other 468 452 450 449 448 447
=
Total 1, 293 1, 288 1, 301 1, 323 1, 347 1, 368
Deposit insurance 49 17 5 -7 - 16 - 20
Offsetting receipts -67 -69 - 7 -74 - 76 -79
Net interest 204 221 236 247 254 254
&& && &&
Total 1, 479 1, 457 1, 470 1, 489 1, 509 1, 523
Revenue 1, 162 1, 242 1, 323 1, 390 1,455 1, 534
Deficit 317 215 147 99 54 - 1 1
Debt 3,317 3,532 3, 679 3,778 3,832 3,821
NOTE: C8Oprojections (Table 4. 1 ) less the amounts saved by implement-
ing the authors' recommendations.
Many benefciaries of current federal programs, of course, will
regard the proposed cuts a s draconian. So be it. After the cuts are
made, however, the federal budget would still finance the largest
defense budget in the world, maintain the real pension benefits of
Social Security recipients, fnance a continued substantial increase
in expenditures for medical care, and maintain most other domestic
programs. Total outlays in FY98 would be 18. 8 percent of GDP, a
higher share of national output than in any peacetime year prior
to the 1970s. And total outlays for domestic programs would be
14. 5 percent of GDP, a higher share of national output than in any
year prior to the 1980s.
Finally, Table 4.4 summarizes the path to a balanced budget.
The combination of measures described above would yield a small
surplus in FY98 and a rough balance in the several subsequent
years. Further changes in federal medical programs would still be
necessary to put those programs on a sustainable basis. For the
first time in 30 years, however, we would be financing total federal
101
MARKET LIBERLISM
outlays without increasing the tax burden on either current workers
or their children. It is not very important to achieve a balanced
federal budget every single year, but it is very important to try.
That is the only way to force a sorting out of our fiscal priorities
and to constrain total federal spending to a level that is broadly
supported.
102
. Reduce Federal Regulation
William A. Nisknen
Federal regulation has become a major burden to the U. S. econ
omy. The gross annual cost of federal regulation is now about
$500 billion and is expected to increase, under current trends and
recently enacted legislation, to about $600 billion by the year 2000
(both estimates in 1990 dollars) . l Moreover, the new Congress is
expected to address several bills that would further increase those
costs-including mandated family leave, mandated health insur
ance, extending the Medicare compensation rates to all private
payers, and the first federal regulation of the insurance industry.
The cost of regulation is often a special burden on small firms and
has contributed to increased foreign sourcing by large firms.
The Record of Economic Deregulation
The record of economic deregulation, initiated by Presidents Ford
and Carter and sustained by President Reagan, is now quite clear.
Since 1976 the older forms of price and entry regulations have been
successively reduced or eliminated for domestic aviation, railroads,
trucking, banks, oil, intercity buses, long-distance telephone ser
vice, ocean shipping, cable television, and natural gas production.
In every case, deregulation led to an increase in services and (except
for cable TV) a reduction in real prices to consumers. The annual
net benefts of deregulation are now about $50 billion. Deregulation
also led to some restructuring within each of the affected industries
and some pressure for reregulation-especially of airlines, rail
roads, banking, and cable TV. The effects of the partial deregulation
of banks were especially misunderstood, and the savings-and-Ioan
crisis led to some new regulation of bank capital standards and the
asset portfolios of the S&Ls. And the increase in cable T rates led
iThomas D. Hopkins, "The Costs of Federal Regulation," Journal of Regulation
and Social Costs, March 192, p. 25.
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MARKET LIBERALISM
to some recent reregulation of that industry. For the most part,
however, there appears to be a political consensus to maintain the
deregulation of most of those industries. One wonders why the
lessons from recent experience have not led to further deregulation
of the partially deregulated industries and to deregulation of other
industries.
The Regulatory Record of President Bush
For three years, in the name of a kinder and gentler America,
the Bush administration encouraged or allowed a rapid increase in
regulation. President Bush nominated aggressive regulators to head
the Environmental Protection Agency, the Food and Drug Adminis
tration, and the Securities and Exchange Commission. More impor
tant, the administration endorsed a series of new regulatory laws
that will impose substantial continuing costs on the economy,
including
a higher minimum wage,
a complex new compensation schedule for physicians' services
financed by Medicare,
the Americans with Disabilities Act,
the Clean Air Act amendments of 1990, and
the Civil Rights Act of 1991 .
Moreover, the administration allowed the White House regulatory
review process to be weakened by the absence of a confirmed
nominee to head the Office of Information and Regulatory Affairs
(OIRA) and by allowing Congress to circumscribe the effectiveness
of that office.
The Bush administration, to its credit, made several proposals
to reduce the older forms of economic regulation. One proposal
would have eliminated the restrictions on interstate banking and
on the range of financial services offered by banks, but Congress,
maybe correctly, deferred approval of that proposal until the
deposit insurance issue is resolved. A proposal to reduce the regula
tion of public utility holding companies was approved in late 1992.
In response to pressure from the White House Council on Competi
tiveness, the Food and Drug Administration implemented several
measures to reduce the time required for approving new drugs.
And Bush appointees at the Federal Communications Commission
104
Federal Regulation
and the Federal Energy Regulatory Commission also initiated sev
eral valuable deregulatory measures.
The net increase in the cost of federal regulation during the
Bush administration has not been estimated (the Clear Air Act
amendments alone will cost about $30 billion a year when the
new rules are fully implemented), but the indirect indexes of the
magnitude of federal regulation are most disturbing. The number
of employees in federal regulatory agencies increased from 106, 000
in 1989 to 122,400 in 1992. The number of pages added to the Federal
Register each year increased from 55,000 to 70,000 in the first two
years of the Bush administration.
In the fall of 1991 President Bush-who, as vice president, had
served as chairman of both the Task Force on Regulatory Relief
and a special task force on financial reform-apparently had a
change of heart. Concern about the sputtering economy and long
term economic growth led the Bush administration to change course
on yet another dimension of its economic policy. In his January
1992 State of the Union address, President Bush announced a 90-
day moratorium on new federal regulations that would reduce
economic growth. Bush later extended the moratorium for another
120 days and committed the administration to estimating and
announcing the expected benefits and costs of future regulatory
bills considered by Congress. The administration released a (dis
puted) estimate that the initial 90-day moratorium reduced the long
term costs to consumers and workers by $15 billion to $20 billion.
2
Most of the proposed new rules, however, were written by men
and women that Bush had appointed under laws that he had
endorsed, inherently limiting the potential effect of the 1992 mora
torium. Bush was not initially ready to replace any of the key
regulatory officials or to criticize any of the basic regulatory legisla
tion. After considerable controversy within the administration,
however, Bush resisted any major new commitments at the 1992
Earth Summit. And during the presidential campaign, Bush raised
questions about some of the basic environmental legislation and
vetoed bills to mandate family leave and reregulate cable TV.
2
0ffice of Management and Budget, Mid-Session Revie of the Federl Budget, July
1992, Q. 395.
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MARKET LIBERALISM
Those actions raised the question of which was the real Bush,
the "environmental president" of the 1988 campaign or the "people
first" president of the 1992 campaign? The most likely answer is
both. Bush had a genuine concern both about the environment and
about regulations that cost too much in lost output and jobs. In
that sense, the Bush position did not differ much from that of
Democratic candidate Arkansas governor William Clinton, but it
did differ sharply from the quasi-religious " earth first" environmen
talism of Clinton's running mate Al Gore.
The regulatory record of the Bush administration is probably best
explained by a combination of economic and fiscal conditions. Good
times produce new political demands, and the long Reagan recov
ery should have been expected, with a lag, to increase the demand
for environmental benefits, aid to the disabled, and the like. The
federal fiscal condition, however, increased the incentive to meet
those demands by regulation rather than by additional spending
or tax preferences. The weak economy of the past several years,
in turn, has deferred demands for new regulation and increased
concern on the part of both the administration and Congress about
the effects of regulation on output and employment. For those
who are concerned about the prospect of a continued increase in
regulation, the current challenge is to shape the perspective on the
appropriate limited role of regulation before an economic recovery
revives proposals for new regulation.
A Deregulatory Agenda for the New Administration
A regulatory reformer faces the same type of challenge as a
budget reformer: eliminate those regulations that never did or no
longer do serve the general interest, revise the remaining regula
tions to increase their efficiency and responsiveness to changing
conditions, and promote a set of principles and a review process
that will lead to better decisions on proposed new regulations. That
is a massive task and will not be completed in the course of one
administration or, probably, one lifetime. Nevertheless, it is worth
while to consider a regulatory reform agenda for each new adminis
tration. A president of either major party will want to maintain an
effective White House regulatory review process. Regulation is now
too large a burden on the American economy to treat casually
without a guiding set of principles.
106
Federal Regulation
Economic Regulation
Most types of economic regulation, whatever their public ra
tionale, have increased the average price of goods and services sold
by the regulated industry, thus protecting existing firms against
potential new domestic and foreign competitors at the expense of
American consumers. Many of those regulations have also led to an
artificial structure of the regulated industries, reducing productivity
and the range of goods and services offered for sale. As a conse
quence, the selective reduction of federal price and entry controls,
which began in the late 1970s, has generally led to lower prices,
higher productivity, and an increased range of goods and services.
The only exception to that pattern was the deregulation of cable T
rates without allowing additional firms to enter each local market.
Recent experience should lead the new administration to consider
the following steps to reduce economic regulations.
Agriculture
Eliminate those marketing orders that restrict the sale or size of
fresh produce.
Eliminate the milk marketing system and the ban on reprocessing
powdered milk for human consumption.
Eliminate the import quotas on dairy products, meat, peanuts,
and sugar.
Communications
Allow the regional telephone companies to manufacture equip
ment and offer cable T and information services.
Establish property rights in the electronic frequency spectrum
and allow market exchanges of those rights.
Require government users of the frequency spectrum to pay user
fees.
Eliminate the Intelsat monopoly on international satellite com
munications.
Consider federal preemption of state regulation of local telephone
service where cellular telephone is a viable competitor.
Energy
Repeal the Public Utility Holding Company Act.
Allow free entry in electric generation.
3
Regulation, Winter 1992, includes a set of articles on the regulation of electric
utilities.
107
MARKET LIBERALISM
Eliminate rate controls on electric transmission grids and gas
pipelines that are user owned.
Repeal the several types of mandated energy conservation regu
lations.
Consider substituting regional for state regulation of local electric
and natural gas distribution companies.
Finance
Eliminate the restrictions on interstate banking.
Eliminate the restrictions on the services supplied by bank hold
ing companies, in combination with a major reform of the regula
tion of insured depository institutions.
Eliminate the restrictions on the types of assets that may be
owned by commercial and savings banks.
Consider establishing a federal charter for insurance companies;
those firms electing a federal charter would be subject to federal
solvency regulation but would be free of state rate regulation.
Consider changing those federal securities regulations that penal
ize insider trading and restrict takeover bids.
Trade
Approve the North American Free-Trade Agreement. s
Complete and approve the Uruguay round of multilateral trade
negotiations.
Repeal the anti-dumping provisions of U. s. trade law.
Consider establishing a free-trade agreement with any country
that is prepared to grant the United States equal treatment.
Transportation
Repeal the remaining rate controls on trucking, railroads, and
ocean shipping. 6
Allow increased access by foreign airlines to the U. S. market in
exchange for similar access by U. S. carriers to the markets of the
foreign airlines' home countries.
4
Regulation, Spring 1991 and Spring 1992, includes a set of articles on banking
and insurance regulation.
S
Regulation, Winter 1993, includes a set of articles on current trade issues. Brink
Lindsey makes the case for a more ambitious unilateral free-trade agenda in chapter
13 of this book.
6
Regulation, Summer 1991, includes a set of articles on transportation regulation.
108
Federal Regulation
Allow foreign shipping lines to carry traffc between U. S. ports.
Eliminate the Postal Service monopoly on first class mail.
Consider federal preemption of state rate controls on intrastate
traffic.
That is a substantial agenda but far from complete; for example,
some parts of U. s. antitrust and labor law should also be reviewed.
Implementing any substantial part of the proposed agenda, how
ever, would generate meaningful benefits for the U. S. economy.
Those measures would also generate some budget savings, because
they would permit the elimination of the Interstate Commerce Com
mission and the Federal Maritime Commission and a substantial
reduction in the staff and budgets of the Federal Communications
Commission, the Federal Energy Regulatory Commission, the
International Trade Commission, and the Securities and Exchange
Commission. To facilitate implementation of any part of the agenda
outlined above, the president should make a case for continued
economic deregulation as part of a general strategy to increase
productivity, appoint committed deregulators to the relevant com
missions, and enlist the support of those private interests and state
governments that would be best served by the proposed measures.
Social Regulation
Most of the increases in the costs of federal regulation are attribut
able to broader and tighter regulation of health, safety, and the
environment. From 1977 to 1990, for example, the cost of federal
economic regulation declined about $45 billion, but the cost of
social regulation increased about $67 billion (both in 1990 dollars) . 7
Moreover, most of the projected increase in the cost of regulation
is attributable to new social regulations approved in the part several
years.
There is reason to presume, and considerable evidence, that most
economic regulations are counterproductive. The issues touched
by social regulation are much more complex. Most health, safety,
and environmental concerns could be addressed by some combina
tion of information, contract or tort law, insurance, fiscal measures,
and regulation. The relevant question is whether regulation is the
7
Hopkins, p. 25.
109
MARKET LIBERALISM
most efficient instrument to address those concerns, and the
answer, in many cases, is no.
Safety and Health. The record of the Occupational Safety and
Health Administration (OSHA) illustrates that point. OSHA sets
workplace safety standards, inspects about 1 percent of workplaces
each year, typically finds a few violations per inspection, and levies
small fnes. In 1982, for example, OSHA assessed about $6 million
in fines at a time when firms paid about $10 billion in premiums
for workers compensation and about $69 billion in compensating
wage differentials in the less safe workplaces; OSHA's fines are
trivial in comparison with other financial incentives to reduce work
place risk. In addition, occupational safety is a function of both
workplace conditions and employee behavior; a safer workplace
may induce less careful employee behavior and thus have little net
effect on accident rates. One should not be surprised that there is
no evidence that OSHA has significantly increased occupational
safety and health. For similar reasons, there is no evidence that
the Consumer Product Safety Commission (CPSC)9 or the National
Highway Traffc Safety Administration (NHTSA) has significantly
increased product or traffic safety. In commercial relations, in both
the labor market and the markets for goods and services, there
should be a strong presumption to rely primarily on information,
contract law, and insurance-not on regulation-to achieve a mutu
ally acceptable level of health and safety. The direct and indirect
costs of OSHA, CPSc, and NHTSA are substantial, yet their activi
ties have no significant effects on health and safety. Those agencies
may best be eliminated or restricted to a research, information, and
advisory role. One wonders how our occupational and product
safety were protected before the creation of those agencies about
25 years ago; the answer is, "Quite well, thank you. " Death rates
from accidents of all types declined steadily for many decades
before those agencies were created.
The Food and Drug Administration (FDA) seems to assume that
drug companies are irresponsible, physicians are incompetent, and
all patients are children. Extraordinarily demanding tests of both
&homas Knieser and John Leeth, "Improving Workplace Safety, " Regulation,
Fall 1991, pp. 670.
9
Paul Rubin, "Why Regulate Consumer Safety?" Regulation, Fall 191, pp. 58-63.
110
Federal Regulation
the safety and the effectiveness of new drugs have substantially
delayed the approval of new drugs, reduced the number of new
drugs introduced, increased the price of all drugs, and restricted
the subsequent use of approved drugs. 10 The average time required
to approve a new drug in the United States is about twice that
required in Europe. The average cost to the drug companies per
new drug approved is now about $250 million. FDA regulations
on advertising and labeling have reduced the flow of information
to physicians and consumers. Under pressure from AIDS activists,
the FDA has allowed some drugs to be used before complete testing
for effectiveness but only on an exceptional basis. Under pressure
from the White House, the FDA has recently implemented several
measures to reduce the time required to approve new drugs. Those
recent changes indicate that the FDA has substantial flexibility
under current law. The primary lesson here is that the new adminis
tration should appoint a sensible FDA administrator and maintain
pressure on the FDA as part of a more general strategy to reduce
the rapid inflation of the price medical care.
The Environment. The BOO-pound gorilla in the mountain of
social regulation, of course, is the Environmental Protection Agency
(EPA). The total cost of environmental regulation is now about 3
percent of gross domestic product. 11 More important, the benefits
of most recent environmental regulations appear to be substantially
less than the costs. Most of the problems of environmental regula
tion are attributable to the major environmental laws and could
not be substantially reduced without changing those laws. Con
gress, with the endorsement of most pres
.
idents from Nixon
through Bush, has set progressively broader and tighter environ
mental standards and, in many cases, has prescribed the means of
achieving those standards. The EPA has some discretion and
should make use of better scientific information and risk assessment
procedures, but the cost of environmental regulations will continue
to increase unless the major laws are changed.
Some amount and type of regulation is the most efficient means
of addressing many, maybe most, environmental concerns. In the
IDMichael Ward, "The Overregulation of Legal Drugs," Regulation, Fall 1992.
lIDale Jorgenson and Peter Wilcoxen, "Environmental Regulation and L. b. Eco
nomic Growth," RND Journal of Economics, Summer 1990, pp. 3140.
111
MARKET LIBERALISM
absence of extensive property rights in air, water, migratory ani
mals, and the like, most people treat those resources as a common
pool. And, given the dispersion of botp polluters and the popula
tion affected, tort law is not sufficient to address those concerns.
A major reform of environmental laws, not a mindless proliferation
of new laws and regulations based on insufficient scientific informa
tion and inadequate economic analysis, should be the goal of the
new administration. That may be politically easier for a Democratic
administration with a clear commitment to broadly shared environ
mental concerns. The maj or principles that should guide the
reform, I suggest, are the following:
Broaden property rights in the common-pool resources as much
as possible. That is most likely to be effective when there is a
small number of identifiable polluters and the effects are quite
localized. In those cases, tort law can be an adequate means of
social control .
.
Do not set national standards to meet unusual local or regional
concerns . Such standards are likely to be too high for most
regions and too low for some regions.
Do not set a standard if the scientific evidence is not clear. It is
easier to set a standard later than to repeal a mistaken standard.
That is most important for potentially very expensive measures,
such as those to reduce global warming.
Set standards at a level such that the expected marginal benefits
equal the marginal costs, given the authorized means to meet the
standard.
In general, strengthen the scientific and economic bases for esti-
mating risks and setting standards.
Public support for environmental measures will increase if citizens
have a better sense that existing measures are effective and generate
net benefits. For that reason, the new administration should
appoint a credible environmental reformer, not an ideologue or an
imperialist, as EPA administrator and make the case for a major
reform of most existing environmental laws.
One set of environmental programs (not administered by the
EPA) presents a special problem: endangered species, 1
2
wetlands,
12Robert J. Smith, "The Endangered Species Act: Saving Species or Stopping
Growth?" Regulation, Winter 1992, pp. 83-87.
1 12
Federal Regulation
and historic properties. The benefits of those programs are diffused,
but the costs are concentrated on the specific property owners
whose rights of use have been expropriated by a regulatory taking.
The costs of those programs, should be paid from the general tax
base, rather than by the current owners of the affected property.
Moreover, our political system would make much better decisions
on what species, wetlands, and properties to protect if the costs
of acquiring the relevant easements were on the budget than if
they are acquired by an uncompensated regulatory taking. And
the current owners would have better incentives to maintain those
characteristics of their property that are of general value to others
if they faced potential compensation rather than expropriation.
Those three programs have caused intense outrage among those
who bear their costs, may be unconstitutional, and probably cannot
be sustained. Those programs should also be candidates for careful
review and substantial reform.
Reform of the Regulatory Process
For several years, Congress has weakened the White House regu
latory review process. That partisan action was clearly shortsighted:
a Democratic president would also want an effective and compre
hensive review of new regulatory legislation and proposed new
rules. Among the first actions of the new administration should be
to appoint an able political official to head OIR and to strengthen
that office.
More recently, several proposals for reforming the regulatory
information and review process have been considered. One pro
posal would create a regulatory budget similar to the fiscal budget.
My judgment is that periodic estimates of the costs of regulation,
rather like the estimates of tax expenditures, provide useful infor
mation, but that those estimates are too imprecise for a regulatory
budget to be an effective instrument of cost control.
More promising is a proposal, considered by the Bush administra
tion in 1992, to issue an executive order on risk assessment proce
dures. The current procedures for estimating the risks of potential
carcinogens, for example, involve an extrapolation from the effects
on rodents of very high doses to an estimate of the effects on
humans of very low doses; there is reason to believe that current
procedure overestimates risks by several orders of magnitude, and
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MARKET LIBERALISM
few of the estimated risks have been confirmed by epidemiological
evidence. 13 A more accurate process of risk assessment could sub
stantially reduce the number of toxins subject to regulation without
any change in the legislated standards.
And third, a broad bipartisan coalition in Congress has recently
endorsed a proposal to require an analysis of the economic impact
of all new proposed regulatory legislation and proposed rules,
authorizing any member of Congress to enforce the requirement
by a point of order or any citizen to do so by a legal challenge. 14
That measure would probably slow the growth of new regulations,
but it risks creating a paper mill . The major limitation of that
approach is that it does not force a similar periodic analysis of the
huge body of existing regulatory laws and regulations.
More promising than any identifiable change in the regulatory
process would be a revival of the constitutional doctrines limiting
restraints on interstate commerce, restrictions on private contracts,
the uncompensated taking of property rights, and the undue dele
gation of policy decisions to regulatory agencies. Unfortunately,
discussion of those more important and more complex issues must
be postponed until another day.
1
JRichard B. Belzer, "The Peril and Promise of Risk Assessment," Regulation, Fall
1991, pp. 40-49.
Ihe Fiscal Accountability and Impact Reform (FAIR) Act, introduced in July
1992 by Rep. James P. Moran (D-Va. ) .
1 14
b. Government Regulation: The Real
Crisis in Financial Services
Bert Ely
The savings-and-Ioan crisis has garnered enormous attention in
recent years, as have problems in the banking and state-regulated
insurance industries. Less attention has been focused on govern
ment regulation, which is common to and underlies the problems of
those industries. Government regulation is the real crisis in financial
services. An inherently flawed regulatory mechanism caused the
S&L crisis and then magnified that crisis once it erupted. That same
mode of regulation, which also has caused serious problems in
banking and insurance, increasingly distorts the financial services
marketplace.
This chapter will first discuss the increasingly evident and irrepa
rable shortcomings of government regulation of financial services,
notably safety-and-soundness regulation that seeks to prevent the
failure of individual financial institutions. It will identify the many
costs defective government regulation imposes on the economy
and then present the standards that any sound regulatory mecha
nism for financial services must meet. The chapter will close by
summarizing the 100 percent cross-guarantee concept for privatiz
ing deposit insurance in a manner that meets those regulatory
standards. The cross-guarantee concept is embodied in legislation
Rep. Tom Petri (R-Wis. ) introduced on September 3D, 1992.
The S&L Crisis-Regulation Gone Amuck
The S&L crisis is the purest example of government regulation
gone amuck. The roots of this crisis reach back to the 1930s, when
federal deposit insurance was enacted. Federal policies of that era
also encouraged S&Ls to begin funding their long-term, fixed-inter
est-rate home mortgages with short-term deposits. That "maturity
mismatching" transformed S&Ls into very unsound financial insti
tutions. Numerous regulatory strictures imposed on S&Ls during
115
MARKET LIBERALISM
the postwar years made them more unsound. The most notorious
of those impositions occurred in 1966 when the Federal Reserve's
deposit interest rate controls were extended to S&Ls. By the late
1970s the S&L industry was a disaster waiting to happen.
Disaster struck in 1979 when the Fed, no longer able to keep the
lid on interest rates, let them skyrocket. Overnight, Paul Volcker
became a convert to monetarism. S&Ls collectively lost $9 billion
in 1981 and 1982. High interest rates trimmed the value of S&L
mortgage portfolios, driving the industry at least $100 billion under
water. Unfortunately, in addition to bungling deregulation and
failing to reform deposit insurance, the Reagan administration
avoided addressing the S&L crisis. ! It was not tackled until the
beginning of the Bush administration. 2 By then, however, the
groundwork had been laid for a legislative and regulatory overreac
tion to the S&L crisis that has proved the old adage that regulation
is like a broken clock-it is almost always wrong. The only question
is by how much.
Goverment Regulation Is the Underlying Problem
To date, the political process has tried to put the regulatory
Humpty Dumpty back together by attempting to make regulation
work better, primarily by giving regulators more power to micro
manage banking and insurance firms. Regulatory micromanage
ment, however, will simply continue to burden America with a
risky and inefficient financial services industry that increasingly
resembles the totally discredited central planning practiced in the
former Soviet Union and Eastern Europe. The time has come to
bring perestroika to America's financial services industry.
Attempts to make established regulatory philosophies work more
effectively will not succeed because the political process focuses on
the consequences of faulty regulation rather than the real causes
of problems in banking and insurance. Most public policy analysts
) Joe Stilwell, "The Savings and Loan Industry: Averting Collapse," Cato Institute
Policy Analysis no. 7, February 15, 1982, provided one of the first warnings about
the looming S&L crisis. Congress and the administration ignored that warning, as
they did many others.
2 Bert Ely and Vicki Vanderhoff, "Lessons Learned from the S&L Debacle: The
Price of Failed Public Policy," Institute for Policy Innovation, February 1991,
describes 16 different public policy failures that contributed to the S&L crisis. Nine
of them predate 1979.
116
Financial Services
today are about as skilled in detecting the causes of problems that
attract political attention as 18th-century physicians were in detect
ing the causes of diseases.
In sum, the underlying crisis, common to all financial institutions,
is the predictable failure of the political micromanagement of mar
ketplace activities. Sadly, that failure has not been recognized, even
as its consequences are routinely decried. Instead, the political
process, fearful of losing power over the marketplace, proceeds
further and further up the blind alley of government regulation.
Why Financial Serices Regulation Has Become Obsolete
Financial services regulation does not work as well as it once
seemed to because electronic technology, specifically computers
and modern telecommunications, has destroyed the efficacy of this
form of regulation. Effcacious regulatory schemes work tolerably
well only if three conditions are met.
First, the technology and other external factors affecting a regu
lated industry must change very slowly because the political process
that enacted the regulatory scheme adapts very slowly to change,
primarily because change harms the status quo, which heavily
influences the political process. The future, unfortunately, does
not have its own political action committee. Electronic technology,
of course, is rapidly altering the economics of providing financial
services and threatening the existence of many types of firms, such
as stock brokers, insurance agents, S&Ls, and real estate agents.
Second, the regulated industry must be easily isolated from the
rest of the economy in order to avoid confusion about who shall
be among the regulated. Technology, however, has permitted the
unbundling of financial services transactions, such as home mort
gages, so that various pieces of those transactions can just as easily
be performed by an unregulated firm as by a regulated firm. In
effect, unbundling has fuzzed the lines of demarcation between
the highly regulated and the unregulated. The highly regulated,
such as banks, s&Ls, and insurance companies, quickly lose market
share to unregulated firms that skim off the more desirable pieces
of the business, such as lending to low-risk borrowers.
3 Bert Ely, "Technology, Regulation and the Financial Services Industry in the
Year 20 , " Issues in Bank Regulation 9, no. 3 (Fall 198): 13-19.
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MARKET LIBERALISM
Third, all firms operating under a particular regulatory regime
must be relatively homogenous so that all can reasonably expect
to make an acceptable rate of return on their equity capital. As a
result, firms in a regulated industry tend to have similar operating
styles because all participants must adapt to the same regulatory
scheme. But because homogeneous operating styles do not serve all
segments of a market equally well, unregulated frms differentiate
themselves in order to compete successfully against regulated
firms. Regulated firms respond by trying to act as much like unregu
lated firms as they can, specifically by attempting to match the
specialization and differentiation of their unregulated counterparts.
Regulatory strictures, though, chafe badly in this environment, and
one size no longer fits all, or even a few.
Regulatory invasions also set off regulatory turf wars. For exam
ple, the Securities and Exchange Commission (SEC) and the bank
regulatory agencies have battled recently over mark-to-market
(MTM) accounting. The SEC favors MTM for publicly held banks
and thrifts. All four bank and thrift regulatory agencies, however,
vigorously oppose MTM, as much because they are aggressively
fighting the SEC's attempt to intrude onto their long-held regula
tory turf as for substantive reasons. Of course, the existence of four
bank and thrift regulatory agencies, when one agency would do,
further impairs the efficiency and therefore the competitiveness of
banks and thrifts.
Regulatory turf battles, as well as parallel turf battles among
regulated industries, reflect the underlying war-the titanic strug
gle between the political process and the marketplace for control
over the financial services industry and the flow of capital in the
economy. The amount at stake is significant: at the end of 1991 the
nation's private-sector financial institutions held almost $13 trillion
in assets,4 more than twice the nation's annual gross domestic
product (GOP) . Contrary to trends elsewhere in the world, particu
larly in the former communist countries and the Third World, the
political process in the United States is steadily gaining power over
the financial services industry at the expense of the marketplace.
4
"Balance Sheets for the U. S. Economy, 196-91," Board of Governors of the
Federal Reserve System, September 28, 1992, p. 35.
118
Financial Services
Government Regulation Is Very Expensive for the Economy
Federal and state regulaton of financial services, specfically bank
ing and insurance, has been very expensive for the American econ
omy for five reasons. These reasons go beyond the $200 billion cost
to taxpayers (on a present-value basis) of the S&L crisis. They
include the cost of failures of financial institutions, the cost of
distorting the financial market's allocation of credit, regulatory
protections for obsolete firms, regulatory arbitrage that promotes
less efficient funds intermediation, and unintended and difficult-to
measure consequences for the entire economy caused by regulatory
micromanagement of some financial service providers.
First, the total cost of failures of financial institutions since 1981,
when the S&L crisis really kicked off, approaches $300 billion. That
amount includes not only the taxpayer cost of the S&L crisis, but
also the cost of insolvency losses to surviving banks and thrifts
(which they have paid for through higher deposit insurance assess
ments) and the capital of failed banks and thrifts wiped out by
losses prior to the failure of those institutions. The $300 billion sum
equols about 5 percent of current GOP. It also equals the nation's
net investment in fixed assets for 1990 and 1991 combined. 5
Second, government regulation of financial institutions has
greatly distorted the credit allocation process. The regulatory pro
ess causes suboptimal investing funded partially (or in some cases
entirely) by loans made by banks, thrifts, and insurance companies.
Consequently, the nation's inadequate savings are not being put
to their most productive use. The Congressional Budget Office
has estimated that the S&L crisis caused $500 billion in lost GOP,
measured in 1990 dollars. 6 "The chief impact of the [S&L] crisis
was to waste or risallocate billions of dollars of savings that would
otherwise have been invested in [more productive] assets. "7 The
overbuilding of commercial real estate in recent years is the best
visual evidence of that waste.
Net investment equals gross fxed investment in those years in residential and
nonresidential structures and producers' durable equipment minus consumption
of fixed capital, as estimated by the Bureau of Economic Analysis, U. S. Department
of Commerce.
6"The Economic Effects of the Savings and Loan Crisis," Congressional Budget
Office, January 1992, p. 35.
7
Ibid. , pp. 30-31 .
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MARKET LIBERALISM
Government Regulation Causes Underpriced Credit
For the following reasons, the interaction of the frst two reasons
causes credit to be underpriced, which not only leads to credit
misallocations, but in extreme cases helps inflate speculative asset
bubbles that inevitably burst.
Federal deposit insurance protects depositors in banks and thrifts
while state guaranty funds protect those insured by insurance com
panies. Losses incurred in protecting depositors and insureds are
assessed against surviving firms on a nonactuarial basis years after
the actions that caused the losses were undertaken. Consequently,
under the present insurance and guaranty schemes, potential losses
from bad lending and investing decisions are not charged against
the persons who make bad decisions at the time they make them.
The future cost of bad decisions is therefore not incorporated in
the interest rate charged for those loans or in the yield sought from
those investments. The same analysis holds true for the protection
given to customers of securities broker-dealers by a government
chartered corporation, the Securities Investor Protection Corpora
tion.
In effect, credit offered by banks, thrifts, and insurers often is
underpriced, sometimes significantly so, because it does not incor
porate the cost of the option depositors and insureds have on the
capital of others should their bank, thrift, or insurer fail. Regulatory
micromanagement, such as limits on loans to any one borrower or
prohibitions on certain types of investments, attempt to minimize
such losses. But the events of the 1980s demonstrate that regulatory
micromanagement cannot prevent them.
Underpriced credit inflates speculative bubbles because potential
returns on the speculation, such as in the stock market or real
estate, look very promising relative to the price of the borrowing
used to help fund the speculative investment. Eventually, though,
some event bursts the bubble. Bursting bubbles cause severe asset
deflations that dramatically increase the failure rate of highly lever
aged lenders, such as banks, thrifts, and life insurers. Asset defla
tions also increase the leverage ratio of the owners of those assets,
often at a time when the cash flow they need to service their debts
is shrinking.
In a deflationary environment, many economic actors quickly
become focused on reducing their debts in order to get their balance
120
Financial Services
sheets and debt service burdens back to normal. During the adjust
ment process, which can take several years, those businesses and
individuals curtail their demand for goods and services, especially
durable goods and investments largely funded by new debt. A
prolonged recession, such as America is now experiencing, is the
unavoidable consequence. s Government regulation clearly is a pri
mary cause of the current recession.
Regulation Impedes Financial Services Productivity
Using the regulatory process to protect entrenched and often
obsolete businesses is the third reason the regulatory process has
become costly for this country. Often, the political-regulatory proc
ess has been used to bar or distort technologies, usually to prevent
the melding of different types of financial services activities that
technology has made economically feasible. For example, there is
no defensible reason why many forms of life, property, and casualty
insurance cannot be sold to consumers by banks and thrifts, yet
present law substantially restricts such integrated marketing.
Industry turf wars, over things such as the extent to which banks
and thrifts can engage in insurance or real estate brokerage, employ
scores of high-priced lawyers and consultants. Those turf wars
parallel the ones constantly being waged by the regulatory agencies.
The regulatory process also encourages substantial regulatory
arbitrage that further impairs the efficiency of financial intermedia
tion. That is the fourth way in which financial services regulation
has become very expensive for America.
Regulatory arbitrage occurs when the marketplace shifts funds
intermediation from highly taxed and regulated intermediaries,
such as depository institutions, to less taxed and regulated channels
of intermediation, such as money market funds, the commercial
paper market, asset securitization, government-sponsored enter
prises, and the like. In effect, regulatory arbitrage distorts the inter
mediation process in the same way that tax shelters distorted real
estate investing prior to the 1986 Tax Act.
"The purest and most easily documented example of a speculative bubble, and
its deflationary aftermath, is the American farm crisis of the early 1980s. Bert Ely
and Vicki Vanderhoff, "The Farm Credit System: Reckless Lender to Rural America, "
El y & Company, Inc. , November 1990, presents one analysis of that crisis.
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MARKET LIBERALISM
In many cases the less taxed and less regulated channels of inter
mediation are less efficient (in terms of real resource consumption)
than the more heavily taxed and regulated channels of intermedia
tion. Depository intermediation is more effcient in most cases
because the process of shifting the funding of financial assets from
depository institutions to less taxed and regulated channels of inter
mediation involves a second round of underwriting and adrinistra
tive costS. 9
Some data reinforce that point. The percentage of the total U.s.
workforce employed in banking, finance, and insurance has dou
bled since the end of World War II. The percentage of GOP needed
to finance and insure the tangible assets of the economy (reproduc
ible assets plus privately owned land) also has doubled since the
end of that war.
1
Finally, other unintended consequences of the increased regula
tory micromanagement of the banking and insurance industries
harm the economy in ways that are hard to quantify. Because credit
flows lubricate the entire economy, the importance of those two
industries is far greater than their direct contribution to GOP. In
particular, regulation drives away good management; after all, why
would a talented manager want to work in an industry in which the
regulatory process increasingly constrains managerial discretion,
often irrationally? Hence, a very important sector of the economy
is steadily losing good judgment, at great cost to the overall econ
omy and to the American people.
Why Such Harmful Regulation Exists
Why regulate financial services firms if the outcomes are so bad?
Historically, proponents have suggested several reasons.
First, governments learned long before Willie Sutton was born
that banks are where the money is. Consequently, governments
have long used banks as a means to finance government debt, both
by forcing banks to buy government bonds and by using banks to
sell government debt to the general public. For example, the British
9 Bert Ely, "Commercial Banks Are Not Obsolete-And the Federal Government
Should Stop Trying to Make Them So," Paper presented at the 28th Annual Confer
ence on Bank Structure and Competition, Federal Reserve Bank of Chicago, May
7, 1992. To be published in the proceedings of the conference.
IOIbi d.
122
Financial Services
government initially gave the Bank of England a banking monopoly
in exchange for the bank's owning and underwriting government
debt to help finance the Crown's periodic wars.
1 1
Second, governments have used regulation to protect favored
interests. Restricting entry to regulated lines of business is a key
way in which regulation protects established firms from new com
petitors. The protected usually reciprocate with substantial political
contributions to legislators whose votes support the protection.
Third, there is broad public support for preventing banks, thrifts,
and insurers from failing in order to protect depositors and insureds
from losses arising from such failures.
Fourth, government regulation provides a tool for manipulating
the economy, specifically for controlling the money supply and
allocating credit to borrowers perceived by the political process as
"socially desirable. "
Is Any Regulation Necessary?
Some will argue that all forms of financial services regulation are
unnecessary; therefore, the present regulatory structures should
simply be blown away. That is an enticing thought as the American
economy continues to suffer from a regulatory overreaction induced
by the federal government's failed regulation of the S&L industry.
Clearly, many aspects of financial services regulation serve no legiti
mate purpose and should be abolished. However, some forms of
regulation have proven socially desirable and economically justifi
able over time. For example, one can defend a system of honest
weights and measures and fair and full disclosure, such as truth
in-lending and truth-in-savings regulations, if reasonably applied.
More contention arises over the question of the extent to which,
if at all, the political process should attempt to protect the principal
and accrued interest of depositors and the prepaid premiums, cash
values, and policy claims of insureds. Some argue for "depositor
discipline" -that individual depositors and insureds should assess
the financial condition of their banks, thrifts, and insurance compa
nies and suffer the consequences if they place funds in an institution
that later goes belly up.
"Bert Ely, "Repeal of Glass-Steagall and Ending the Separation of Banking and
Commerce," Testimony before the Subcommi ttee on Technology and Finance of
the House Committee on Energy and Commerce, July 10, 1991, p. 9.
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MARKET LIBERALISM
Depositor discipline is not desirable, though, for two reasons.
First, relying primarily on depositor discipline will not permit
depository institutions to strike an optimal balance between balance
sheet leverage (the ratio of an institution's assets to its capital) and
stability within the financial system. Increased leverage permits all
types of financial intermediaries, not just banks and thrifts, to pass
funds from sources to uses at less cost. However, higher leverage
increases the likelihood that depositors and others with incomplete
information will incorrectly assess the financial condition of the
institution. Incorrect assessments, or "false negatives," will lead
to financial instability, specifically runs on solvent banks and thrifts.
Bank runs are costly because they destroy marketplace franchises
in which depository institutions have invested lots of money. That
destruction represents real economic waste.
Second, the political process will quickly short-circuit depositor
discipline if that discipline leads to costly financial instability. Politi
cal intervention to stabilize a financial system is sound economically
even though the regulatory structure that creates the need for such
intervention is indefensible. To not intervene once a crisis erupts
would be tantamount to destroying the economy in order to save
it. Fortunately, that notion died in Vietnam. Consequently, the
implicit federal policy assumption that big banks and thrifts and
other types of large financial firms are "too big to fail" (TBTF) is
defensible on economic grounds.
1J
The problem with TBTF is that the existing, highly politicized
regulatory process too easily lets individual firms reach the point
where taxpayer funds must be used to protect depositors or
insureds from a loss in order to maintain financial stability. Success
ful firms usually are the first parties taxed to provide that protection; .
in an extreme case, such as the S&L crisis, the general taxpayer is
tapped to provide protection. The cross-guarantee system dis
cussed below will eliminate the need for crisis-driven political inter
ventions because financial instability triggering such intervention
will never occur.
'
2
Bert Ely, "Abandoning Too-Big-to-Fail: The Impossible Dream, " Testimony to
the Subcommittee on Economic Stabilization of the House Committee on Banking,
Finance and Urban Affairs, May 9, 1991.
124
Financial Services
Standards for Justifiable Regulation
Hence, the big question: how to regulate in an economically
sound manner? Simply prescribing more of the same, that is, more
intense regulatory micromanagement, clearly is not the answer.
The appropriate regulatory mechanism for any type of financial
services provider should focus only on legitimate public policy
objectives. Economic manipulation or the protection or enrichment
of favored interests are not legitimate objectives for a regulatory
process armed with the might of the law. By contrast, the following
are legitimate public policy objectives for the financial system.
A stable financial system that works smoothly, efficiently, and
without disruption by protecting depositors and insureds against
losses arising out of the failure of individual financial firms.
A safe financial system in which insolvent firms can be disposed
of without triggering a financial crisis.
Private capital voluntarily placed at risk bears all losses incurred
in protecting the depositors and insureds of failed financial firms.
Honest delivery of financial services.
Privatizing Deposit Insurance through 1 Percent Cross
Guarantees
The public policy challenge for several centuries has been to
develop a market-driven alternative to heavy-handed government
regulation of fnancial institutions that will meet the above objec
tives. The 100 percent cross-guarantee concept meets all four objec
tives while freeing the financial system, or at least banks and thrifts,
from increasingly politicized regulatory micromanagement. The
cross-guarantee concept is based on the notion that less regulation
of the right kind is far better for society than more regulation of
the wrong kind.
The cross-guarantee concept, as applied to banks and thrifts, is
incorporated in legislation Rep. Tom Petri introduced on September
30, 1992. 13 That bill, the Taxpayer Protection, Deposit Insurance
Reform, and Regulatory Relief Act of 1992 (H. R. 6069), meets the
IYhe legislation is summarized in Thomas E. Petri and Bert Ely, "Real Taxpayer
Protection: Sound Deposit Insurance through Cross-Guarantees," Heritage Founda
tion Polic Reie, Spring 1992, pp. 25-29.
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MARKET LIBERALISM
objectives cited above by creating a marketplace that will protect
depositors more efficiently than can government regulation.
.
The Petri bill will create a marketplace in which each bank and
thrift will have to seek a cross-guarantee contract that will protect
all of its deposits and most of its other liabilities and commitments
against any loss or failure to perform should the institution become
insolvent. Qualified parties will voluntarily provide the guarantees
called for in those contracts in exchange for a risk-based premium.
The guarantors can be other banks and thrifts, general business
corporations, insurers, endowment and pension funds, and even
very wealthy individuals.
Each bank and thrift will recruit a syndicate of guarantors from
a large pool of guarantors that meet certain statutory requirements.
The terms of each cross-guarantee contract will be negotiated solely
by the guaranteed institution and its guarantors. Key terms of
contracts will include the formula according to which the risk
based premium will be calculated and the safety-and-soundness
standards that will be applicable to the bank or thrift. Market-driven
premiums, based on leading indicators of banking risk, will deter
unwise lending that feeds speculative bubbles that inevitably burst.
No longer will depository institutions be subject to one-size
must-fit-all government regulation; instead, the marketplace will
tailor safety-and-soundness requirements to the operating style of
individual institutions. The tailoring process will permit banks and
thrifts to specialize and thereby compete more effectively against
firms that currently are less regulated.
The Petri bill creates a regulatory mechanism for the cross-guar
antee marketplace, but the mechanism focuses on the ends or objec
tives of the process, not on how those ends are met. Specifically,
the bill establishes certain requirements for each cross-guarantee
contract and further requires that each contract be approved by a
federal agency before it takes effect. Key statutory requirements
each contract must meet include protecting all deposits and most
other liabilities of the guaranteed institution, mandating certain
"stop loss" limits that will spread large or catastrophic losses widely
but thinly over the capital of many guarantors, requiring that each
guarantor who is not a guaranteed bank or thrift have a net worth
of at least $100 million, and establishing specific risk-dispersion
requirements for each contract and each guarantor. In addition,
126
Financial Services
no cross-guarantee can be canceled or allowed to expire unless a
replacement contract has been obtained.
The Petri bill bars the government from objecting to any contract
provision dealing with the pricing of cross-guarantees, safety-and
soundness requirements imposed by guarantors, or the conditions
under which a bank's or thrift's cross-guarantee syndicate can
assume control of the institution. In other words, the government's
say over contract terms will not extend beyond what is specifically
required by statute.
The cross-guarantee concept, and especially its stop-loss feature,
eliminates all taxpayer risk from deposit insurance. However,
because depositors have come to rely on federal deposit insurance,
the Petri bill retains the federal government as a backup insurer
for deposits up to the present limit of $100,000. The cross-guarantee
system, though, will be so strong that any economic catastrophe
that bankrupted the system would already have caused our increas
ingly indebted federal government to default on its obligations.
Two other features of the Petri bill warrant special mention. First,
the bill is a "narrow bill" in that it reforms only deposit insurance.
It does not address other aspects of banking regulation that restrict
competition or impose unwarranted inefficiencies on banking, such
as branching restrictions and the separation of investment from
commercial banking. Those issues can be dealt with more easily
once deposit insurance has been privatized.
Second, while the Petri bill addresses only federal deposit insur
ance for banks and thrifts, the cross-guarantee concept is applicable
to any type of financial intermediary operating in any market econ
omy in which contracts are readily enforceable. Hence, it will be
relatively easy to extend the cross-guarantee concept to the securi
ties and insurance industries as well as to the financial systems of
other countries.
Conclusion
Government regulation of banks and thrifts has caused great
harm to the American economy, most recently by fostering several
speculative bubbles whose bursting has saddled our economy with
painful asset deflation and a sluggish recovery. Increased regula
tory micromanagement only makes matters worse by employing
an increasing number of bureaucrats to override the marketplace.
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MARKET LIBERALISM
Congress must make a dramatic U-turn by enacting 100 percent
cross-guarantees to privatize deposit insurance and all of the regula
tory apparatus than now encrusts the nation's banking system.
Only then will America begin to enjoy a safe, efficient, and stable
financial system.
128
. Telecommunications: Starting the
Next Century Early
Thomas W. Hazlett
Every candidate endorses apple pie and the American fag. But
just suppose one party also worked quietly to organize a flag cartel,
making flags far too expensive for average patriotic Americans,
and another had arranged to impose production quotas on apples,
seriously restricting the U. S. consumer's ability to enjoy a Golden
Delicious-fresh, baked, or sauced. Would you be shocked? Not
you, you sophisticated yet streetwise analyst of the Pennsylvania
Avenue power corridor.
As coincidence would have it, every candidate is solidly in favor
of improving America's telecommunications infrastructure. It's
apple pie with a little flag stuck in the middle. Atari Democrats
cheer high-tech solutions to America's problems of jobs, education,
health care, and the environment; Republicans rally to endorse
the promise of private-sector dynamism, the wave of economic
development that a new generation of capitalist research and devel
opment will deliver. But established interests have displayed an
aptitude for driving America's telecommunications future in a qui
etly reckless way, blocking traffic and impeding tremendous new
sources of consumer-pleasing innovation. The new administration
can strike a delightful blow for consumer sovereignty by peeling
away the anti-competitive restrictions that have been so artfully
placed in the way of consumers' dialing around the telecommunica
tions marketplace.
If there is any sector of the U. S. economy that should give pro
gressive thinkers hope for the future, it is assuredly telecommunica
tions-a broad infrastructure industry dominated by breathtaking
advances in computing technology, globally propelled by innova
tive American firms. There is much ground for optimism. More
over, the divestiture of the world's largest private company, Ameri
can Telephone & Telegraph, in the dramatic 1984 federal consent
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MARKET LIBERALISM
decree settling U. S. . Western Electric, has proven that regulators
can, in fact, ambitiously create workably competitive market struc
tures to replace creaky (and leaky) monopolistic ones.
The success of the U. S. telecom sector in leading the world into
new services and greater efficiency should burn a nice little warm
spot into the hearts of pro-consumer regulators everywhere.
Indeed, the recent results of the McKinsey Global Institute's world
wide study on comparative economic productivity revealed two
facts that startled even the research group's own team: ( 1) The U. S.
economy leads Germany and Japan by about 20 percent each in
productivity per worker per hour. (2) That lead is primarily
accounted for by American superiority in important service indus
tries such as retailing and telecommunications. 1
The importance of telecommunications i n the global competitive
ness race is beyond doubt. While protection of old-line manufactur
ing industries is a favorite project of the populists, the results of
the McKinsey research indicate precisely the opposite course to
be America's appropriate national economic strategy. America's
productivity lead over Germany actually widened in the 1980s, that
study finds, because of great advances stimulated by the deregula
tion of key U. S. sectors-in particular, telecommunications. The
more competitive U. s. telephone industry, for instance, achieves
double the productivity per worker of the German telephone
monopoly. What prompts even greater enthusiasm for the success
of American regulatory liberalization is that the service sector in
general and the telecommunications sector in particular are, by
every estimate, becoming more central to the overall functioning
of all market economies. Advances in telecom productivity, new
services for U. S. business and consumers, and progressively falling
rates will stimulate greater efficiencies not only in consumer com
munications services but in retailing, basic research, education,
health care and, yes, even manufacturing.
Relying on central planning to pick economic winners is fraught
with danger, as every serious student understands. What is funda
mental to the challenges posed in the telecom sector, however, is
'See Sylvia Nasar, "U. S. Rate of Output Called Best," Ne York Times, October
13, 1992, p. 01 .
130
Telecommunications
that the growth of American entrepreneurship is absolutely depen
dent on increases in the ability of the economy to respond quickly
and accurately to new information. Telecommunications is the
highway upon which such information travels. Despite notable
American successes in allowing new drivers to scale the on-ramp
to this highway, many large obstacles remain if the economy is to
travel at cruising speed. Those potholes on the telecommunications
roadway may be technically removed with great ease; it is the
political forces favoring the status quo that block our highway
crews. Overcoming such inertia is the definition of leadership.
Blurry Vision
There are, by formal mathematical proof, an unlimited number
of detailed, compelling, even internally consistent "visions for
America's telecommunications future. " All of those plans appear
splendid prior to implementation. And they have one extra special
feature: by the time they make a historical splat, the system design
ers will have long since moved on to public fame and political
fortune.
My advice to America's telecommunications planners is to mea
sure history carefully. The evidence underlines the inescapable
limitations of deducing future consumer demands or technical
breakthroughs from the foggy confines of the present. Vision? Only
through a very blurry window.
Fortunately, the rough edges of history more sharply detail where
the policy infrastructure can be laid to induce market innovation.
Attendant to economic progress are a set of basic rules to order
and motivate socially desirable behavior, namely lively marketplace
competition and consumer-appetizing technical change. Our pres
ent institutions have great difficulty in settling on those fundamen
tal preconditions for economic success, not only because they are
fuzzy about achieving them in their own right, but also because
our regulatory system is preoccupied with old questions about how
special considerations are dispensed. That is the familiar bias of
pork-barrel politics.
What a shame. By every account, the U. S. economy now floats
upon the first ripples of a huge wave of telecommunications inven
tiveness. Thanks to the astoundingly rapid decline in the cost of
computational intelligence, technical advances in high-speed, high
quality, digital transmission are swamping the old constraints on
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MARKET LIBERALISM
electronic communications. American firms, in particular, are pio
neering airwave and wireline compression techniques that stand
to revolutionize the way we use the telephone, cellular telephone,
television, and radio networks of today.
Personal communications services (PCS) technology alone prom
ises to compete with cellular phones in the immediate future (2 to
5 years), driving down wireless phone talk-time charges and driving
penetration up 5- to la-fold, and to challenge even our ubiquitous
wireline telephone network (supplied primarily by local exchange
companies) in the medium to long run (10 to 25 years) . The possibili
ties for PCS suppliers to compete in paging, messaging, and data
transmission (with both wireless modems and wireless faxes) are
vast.
The delightful new service applications-from medical devices
that could monitor an outpatient's heart functions with a wireless
link to a local hospital computer, to anti-theft devices that might
track your car-jacked automobile-are limited only by the human
imagination.
And good 01' American technologists will create and build the
systems, attachments, and software that control such gizmos. They
will reduce the cost of wireless telecommunications, rationalize
telephone network messaging, provide tremendous consumer ben
efits, and slash the business operations expenses of u.s. corpora
tions. There are currently over 100 American companies experi
menting with PCS on temporary licenses granted by the Federal
Communications Commission. They are chomping at the bit to
employ some famous Yankee ingenuity to work a little creative
destruction in the telecom sector.
But here's the rub: not a net nickel's worth of consumer satisfac
tion nor a penny's of U. S. business efficiency drops from the PCS
technology unless the federal government allows entrepreneurs
access to the full-fledged spectrum rights necessary to deliver wire
less services. And it looks like the administrative task-the easy,
no-brain part of the digital communications revolution-will take
years and years. The granting of new licenses will be "process
intense," as incumbent suppliers resist challenges to the status quo
and rival interest groups squabble over how new entry rights are
to be divvied up.
What becomes painfully apparent, as telecommunications policy
speeds towards the 21st century, is that traditional structures of
132
Telecommunications
19th-century public utility regulation and early 20th-century broad
cast spectrum licensing are increasingly ill-suited for our public
purposes. There has been widespread recognition of that historical
dilemma, not only within the academic literature. The entire theory
of the federal government's 1974 antitrust suit against AT&T, and
of the 1984 modified final judgment, which it eventually became,
was that the contours separating regulated monopoly from regu
lated competition from unregulated competition were in the midst
of glacial shift. In pulling one part of the old Ma Bell (long-distance
service) out of the franchised monopoly into semiregulated compe
tition, and yanking another part (telephone equipment) all the way
over to, virtually, laissez faire, the government left only one part
(local telephone service) that resembled a traditional public utility.
The government graphically demonstrated the declining impor
tance of textbook regulatory structures in today's world. 2
Elsewhere, we have been neither so focused nor so observant.
Particularly in our management of the electromagnetic communica
tions spectrum-where a 1920s licensing program still reigns
supreme-we have pOintedly failed to move with the times. Take,
for instance, current U. s. policy toward high-definition television
(HDTV).
In 1992 the FCC sought to establish its long-range vision of what
it hopes and assumes will be the next generation of television
transmission technology. The commission established a 16-year
change-out of our old TV sets and broadcasting facilities, the ones
we now use to send and receive TV signals, and upgrade to a new
HDTV standard with much higher resolution (and hence picture
clarity) . The first step on that ambitious road to enhanced home
viewing is for the FCC to select one HDTV standard from the
several now being considered by a federal advisory commission.
That is scheduled to happen sometime in 1993. The plan then calls
for U. S. very high frequency (VHF) and ultra high frequency (UHF)
l do not mean to imply that the modified final judgment ended the discussion
about where appropriate lines should be drawn between competition and monopoly,
regulation and deregulation. I mean only that the government's position in U. S. U.
Western Electric et al. underlined the common inapplicability of old-style rate-of
return regulation. (This pOint was soon seconded by the FCC, which began introduc
ing price caps in place of rate of return. ) On problems associated with the divestiture
and its regulatory aftermath, see Gerald Faulhauber, Telecommunications in Turmoil
(Cambridge, Mass. : MIT Press, 1987).
133
MARKET LIBERALISM
T broadcasters to receive an additional 6-MHz bandwidth (dupli
cating their current allocation) in which to simulcast their present
broadcasts in high definition. (It is presumed that an old TV set
will be unable to receive the new HDTV signals, although convert
ers will probably be available. ) Broadcasters will be required to
phase in their HDTV programming schedule, between 1996 and
2003, or risk losing their licenses altogether. Dual broadcasts will
be required, so as to not abandon viewers who have old TV sets,
until the year 2008. At that time, the change-out should have been
completed, and broadcasters will be required to give back the TV
Signals they currently use.
Sounds a little risky. Here's why. First, no one knows what the
consumer demand for HDTV will be. The consensus view is that
a high-definition picture looks superb-crystal clear, bright and
lively-but only on relatively large screens, say four feet by six
feet. On conventionally sized television receivers, the picture
improvement is minor. Essentially, the HDTV leap forward necessi
tates a major consumer investment in complementary inputs: a wall
unit sufficiently large to display HDTV's superior picture quality and
a viewing room sufficiently spacious to comfortably accommodate
such a screen. A household that prefers to watch small- to medium
sized monitors in small- to medium-sized rooms is not likely to
demonstrate a pronounced demand for the new service. Given that
the price of a large-screen HDTV receiver may well be 10 times that
of a 25-inch set (we don't know what the price premium will be
for HDTV wall units because they are not currently in mass produc
tion), many, most, or even the great majority of U. S. households
may reap no daily viewing benefits from this new investment.
Second, the opportunity cost to millions of consumers who refuse
to make expensive new complementary capital investments is sig
nificant, even if placed in the shadows by the regulatory process:
broadcasting HDTV signals effectively blocks out scores of alterna
tive viewing choices. The U. s. high-definition standard will ironi
cally be an excellent one; because the United States was unable to
match the aggressive approach taken by the Japanese, who got out
in front of the competition with an early standard, the American
HDTV signal is likely to be digital, not analog. Digital transmission
affords great advantages, the foremost of which is the possibility
134
T elecomm unications
of easily manipulating data to more efficiently use any given band
width. Engineers now estimate that perhaps 10 to 20 current chan
nels could be broadcast over a single 6-MHz band using digital
compression techniques. The 1993 HDTV signal, in contrast, will
almost certainly hog the entire 6 MHz for a single channel of pro
gramming. The tradeoff arises: would consumers rather get one
super-duper picture on their wall units or 10 to 20 channels of
existing-quality broadcasts to enhance their video selection and
drive down cable TV subscription prices?3
The FCC's current policy regime presumes it can answer that
question today, and pretty much cover all contingencies through
the year 2008. Nancy Reagan's astrologer would be impressed. The
initiative does include some steps to evaluate trends and change
policy accordingly, but the regulations themselves have the practi
cal political effect of making it unlikely that any midcourse correc
tions will be made. Most pointedly, the rules essentially mandate
that television licensees use a particular broadcast technology. Not
only will the producers of that technology have a vested interest
in the mandate proceeding, regulators will come to identify enforce
ment of the rules with the public interest (and loosening of the
rules as a capitulation to corporate interests-whicb it would be,
in that the only interests with sufficient information and incentive
to lobby for change are firms with a financial stake in the outcome) .
I n any event, the FCC gods must be crazy. The escape valve
that reliably adjusts to changing conditions and the arrival of new
information is market competition. Here, that avenue of adjustment
is blocked off. The federal government, so often condemned for
its short-sightedness, is certainly looking to the very long run,
laying out a 16-year transition to a new technology at a time when
virtually all the information that is important for determining
whether such a plan is in the public interest is unknown. Just how
3George Gilder makes a convincing argument that the HDTV format is already
being made obsolete by rapid advances in television interactivity. To Gilder, the
TV set of tomorrow will be a fast-moving two-way street, which HDTV (with its
very large information requirements) will only slow down. He argues that receiving
prettier pictures will be very low on the consumer's list of priorities. He may be
right, for all the FCC knows. If so, U. S. consumers would be leapfrogged by technol
ogy, chained to an outmoded infrastructure by government policy. See George
Gilder, Life after Television (New York: Norton, 1992).
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MARKET LIBERALISM
unkllown is mind-boggling. Think about the time frame: 16 years.
And invert it.
It was in 1976-16 years ago-that the glue was drying on the
frst Apple computer in Steve Jobs's garage. Within the space of
16 years the personal computer was invented and produced, spread
into every nook and cranny of the modern economy, and grew
into the megaindustry that it is today. Innovation, it seems, moves
at the computational rate of a 486 chip. PCs were word processors,
learning devices, video games, and business tools-and suddenly,
when linked with one another, they became high-capacity networks
substituting for the mainframes of just . . . 16 years ago. How
could that winding pathway of creativity, trial, error, invention,
acceptance, dominance, and displacement have possibly been pre
dicted?
Question: what if, in 1976, the foresight of FCC planners had
been put to the task of mapping out the 16-year change-out from
mainframe to PC? And yes, it is cheating to type your answer on
a Toshiba notebook!
As the world advances, so should our communications stan
dards. Ossified government regulation, nestling so comfortably
into yesteryear's standards, is a drag on social momentum. The
marketplace, when rules are well defined and investments well
protected, harbors no such sentimental attachment to the status
quo. TV broadcasters are far more likely to cater to consumer prefer
ences if the government allows them flexibility about which broad
cast standard to select than if they are tied to the government's
best guess of some 16 years earlier.
One would think that the debacles of past FCC plans would
serve as neon warning lights. The 1952 FCC television allocation
table included room for a vast amount of UHF television transmis
sion: channels 14--82. That 420-MHz tract, which served only trivial
viewing shares over the following decades, ate up a Texas-sized
swath of the radio dial. And it was in a burst of futuristic zeal in
the early 1980s that the commission set aside a healthy band for the
provision of direct broadcast satellite; that advertised competitive
challenge to cable television's multichannel video monopoly has
yet to emerge, but it has succeeded in depriving other proven
technologies, such as wireless cable, of critical channel capacity.
Such gargantuan gambles with the public's telecommunications
136
Telecommunications
interests are likely to be bad bets. Still, the political interests love
to spin that wheel.
What to Do
If the essential problem of regulation is that it is an inflexible tool
that affixes leg weights to a dynamic society, the best telecom
reform would be to unleash private players to compete without
asking permission. The very process of permitting, of directing all
new entrants to request a special license to compete, creates a
haven for incumbent protectionism and sounds the death knell for
Schumpeterian competition. The burden of proof should be shifted
from those who dare to risk their capital on the untried to those
who enjoy the status quo. The movement of federal regulation
away from monopoly protection in wire line telecommunications
toward open network architecture is an attempt to do just that.
The most important step now awaiting us is to free access to the
electromagnetic spectrum-our vital "invisible resource. "4
That crucial mandate can best be pursued via license flexibility.
When the FCC grants a license to a private user, be it an AM
radio broadcaster, a point-to-point microwave service, a cellular
telephone company, or whatnot, that license is very specific about
what frequency space the user is able to occupy. Such licensing
rules are fundamental to the orderly functioning of the telecommu
nications sector. s While policymakers at the FCC and the National
Telecommunications and Information Administration are well
informed about the critical nature of a regime of noninterfering
property rights, they are also aware that the extreme additional
'his term was coined by the late Harvey Levin in The Invisible Resource (Washing
ton: Resources for the Future, 1971).
sit is not necessary that license aSSignments be made through comparative hear
ings or lotteries, as is current FCC practice. The essential point is that exclusive
rights must be established to resources, competing uses of which are mutually
exclusive. Else, a "tragedy of the commons" ensues. Rights could be assigned in
ways other than "public interest" licensing. For instance, Coase details how the
most straightforward means of assigning property rights would b by auctions.
Ronald Coase, "The Federal Communications Commission," Journal of Lw & Eco
nomics 2 (October 1959): 1-40. The author has shown that broadcast spectrum rights
were first awarded in the United States via homesteading rules of common law, or
"priority in use." Thomas W. Hazlett, "The Rationality of U. S. Regulation of the
Broadcast Spectrum," Journal of Lw & Economics 33 (April 1990): 133-75.
137
MARKET LIBERALISM
regulatory constraints attached to licensees inhibit the realization of
all but a tiny fraction of the social benefits of the invisible resource.
The FCC manages the spectrum by performing two broad func
tions. First, it engages in a zoning process that separates various
bands along the da, deterg what types of services can be
provided over a particular frequency range. That is commonly referred
to as the alloation process. Once parcels have been zoned for distinct
types of service, the commission must then award them to the licens
ees who w actually use the spectrum. That is called assignment. 6
It is curious that both economists and the popular press have
been critical of FCC policy with regard to assignment and almost
wholly silent on allocation. For instance, the federal giveaway of
free cellular telephone licenses by lottery has received some com
ment in newspapers and magazines, although considering the
dollar amounts involved, the publicity seems quite modest. 7 Econo
mists have focused very narrowly on auctions, however, concen
trating much theoretical discussion on how the government may
obtain the highest payments for spectrum rights. 8
Both quarters have missed the fundamental flaw in spectrum
allocation. Far more important to consumers and u.s. competitive
ness than how the government squanders spectrum license reve
nues is the ability of upstart entrepreneurs with innovative techno
logies to gain access to the telecommunications market in the first
6For a thorough description of the technicalities of FCC spectrum regulation, see
John O. Robinsor, "Spectrum Management Policy in the United States: An Historical
Account," FCC, Office of Plans and Policy, Working Paper no. IS, April 1985.
7In 1991 the NTIA placed the sales value of urban cellular licenses at $79.9 billion.
National Telecommunications and Information Administration, "U.S. Spectrum
Management Policy: Agenda for the Future," U.S. Department of Commerce, NTIA
Special Publication 91-23, February 1991, p. D-S. Those licenses grant broadcast
coverage of about 80 percent of the U.S. population. Instead of selling licenses,
however, Congress constrained the FCC (which had been denied its request to
auction licenses) to dispensing those assets via comparative hearings or lotteries.
The commission chose the latter and conducted lotteries for all but 30 of the 733
markets licensed between 1984 and 1989. License values increased dramatically after
the FCC issued the licenses, however, so it is not likely that the federal government
would have reaped the entire $80 billion to $100 billion (including rural areas)
implied by the above estimates. A very conservative estimate of the aggregate license
values would assume $20 per capita, or $S billion nationally. Thomas W. Hazlett and
Robert J. Michaels, "The Cost of Rent-Seeking: Evidence from Cellular Telephone
License Lotteries," Southern Economic Journal, January 1993.
SA very good analysis of this issue is found in Congressional Budget Office,
"Auctioning Radio Spectrum Licenses," March 1992.
l38
Telecommunications
place. The spectrum bottleneck created by the FCC's Soviet-style
command and control licensing methods severely constrains the
realm within which America's leading high-tech providers can use
their talent and ingenuity to experiment and grow. The rigid limita
tions on licenses implanted during the allocation process, wherein
government planners dictate exactly what services can be provided
via which technology using what standards, strangle new, marginal
players who have an abundance of ideas but a paucity of spectrum
space.
The main goal of spectrum management should be, not to protect
incumbent telecom providers, but to protect customers-who are
best served, not by stable markets that resist change, but by markets
freely accessible to creative risk-takers building better mousetraps.
Squeezing more revenue out of licensees through auctions is fine,
as long as the spectrum is made available quickly and flexibly to
those who can provide new and better service to the public.9 From
an effciency point of view, the issue is not revenue maximization
during the licensing process; it is promoting competition and inno
vation in the telecommunications markets. Auctions can lower the
transactions costs associated with the assignment process, and so
conserve economic resources. But the key issue is getting the spec
trum out into the market and, in the final analysis, driving the
price of spectrum down.
Cheap spectrum should be the goal of telecommunications
policy. It is remarkable that so many regulators believe just the
opposite: that the spectrum is a very valuable social resource and
should be made even more valuable by government policy. (That
view quickly turns into the protectionist view: we have to be
careful about another "disruption of the marketplace" when so
many billions have been invested in spectrum rights.) Radio
waves are an economic input; the output consists of services
delivered to consumers. The more abundant and lower priced
9Under certain circumstances the government may attempt to restrict the number
of licenses issued in order to raise revenues (i.e., it may price the spectrum as a
monopolist would). That is not in the interest of even the U.S. Treasury, however,
because licenses withheld from the public will lower overall economic activity and
reduce tax receipts, and it is assuredly not in the interest of the U.S. taxpayer, who
is also a consumer of telecommunications services. Thomas W. Hazlett, "Revenues
and Efficiency in Spectrum Auctions," FCC, March 1992.
139
MARKET LIBERALISM
that crucial input, the more service delivered to customers, the
more effciency created for U. S. business, and the better the living
standards created for American citizens. Put any patriotic tag on
it that you will: federal policy should aim to reduce the scarcity
value of the spectrum.
You will hear i t said that there i s simply no room on the dial to
do that, that the airwaves are already jammed with a multitude of
users, that our spectrum is too crowded to squeeze in any more
licensees. While competition would be great, there are overwhelm
ing technical reasons why it is impossible.
Indeed, this appears to be true: If you were to invent a wonder
ful new wireless communications service today, you would be
told by a smart Washington lawyer that it is very, very tough to
find any place to put your new service. The airwaves are very
crowded.
But tremendously underutilized. The spectrum is like a 12-lane
superhighway on which traffic is regulated by urban planning
graduates gone mad. Certain lanes are reserved for cars of a
certain color, others are open only to cars bearing special license
plates. Others are reserved for use some time in the next century,
while still others are open only to vehicles with rotary engines.
There is hardly any traffic on this highway, although long lines
of cars wait at the on-ramps (because once or twice a decade
the policeman signals a waiting car to drive on) . So yes, the
on-ramp is very congested, but there is nothing technical about
the tie-up.
All the FCC must do to give wireless telecommunications a
chance for high-speed travel is to give it the green light, to allow
licensees flexibility to devise new ways of speeding down old corri
dors, delivering new services, and employing advanced technol
ogy. The federal government can enforce the boundaries between
the lanes, as it is theoretically supposed to do in its role as traffic
cop of the airwaves. But it should not tell motorists what cars to
buy, how to drive, or what goodies to deliver. The zoning rules
which now inhibit any service or technology that is too creative to
have been drawn on a spectrum map by a government engineer or
too threatening to a respected telecom supplier-are the "technical
reasons" that make the electromagnetic spectrum appear to be so
jam packed.
140
Telecommunications
The loss in social value that zoning restrictions on the spectrum
place on the American economy is enormous, yet hidden from
public view. The new industries that do not develop, the new
technologies that never emerge, the new competition that never
materializes are very difficult to quantify. Moreover, there is no
interest group with a direct stake in this issue: the key information
transmitted to the marketplace is that spectrum rights are extremely
expensive (albeit because of the FCC's creation of artificial scarcity)
and that researching innovative ways to employ wireless telecom
munications is therefore a financially dubious proposition.
But I slightly overstate the case. Some estimates of the value lost
to excessive regulation are now being made because of two things:
First, the ripplings of progressive reform are now coming from the
FCC itself. Second, we are confronted by technological advances
so overwhelming that private interests are pressing their case to
be given the right to "buy out" incumbent users of the spectrum
so as to bring their products to market. The plan to introduce
flexibility into the zoning process has been dubbed "voluntary real
location. " It would merely give present licensees the right to modify
their service menu within their specified frequency band. In prac
tice, it takes the form of a trade: an existing radio spectrum user
agrees to vacate a desirable band to make room for a newcomer
for a negotiated price. (The seller will either relocate to another
frequency, generally a higher band that is less intensely used and
somewhat more expensive to transmit on, or abandon service. )
That is, a market develops. Noninterfering lanes along the spectrum
are dealt to their most highly valued use, as determined by con
sumer demand.
Of course the FCC has been reallocating the spectrum for
decades. When the commission allocated a band for cellular tele
phone service in 1968, it grabbed the top 13 channels (78 MHz) of
UHF television (channels 70-82). But the process is slow and over
lawyered. A pioneering study just released by the FCC's Office of
Plans and Policy shows how market transactions could improve
social welfare in practice. Analyzing the specific question of what
would be the net benefit to society from voluntary reallocation of
one UHF television station in Los Angeles to cellular telephone
service, the authors (one an economist, the other an engineer) find
141
MARKET LIBERALISM
that as of the late 1980s a Los Angeles UHF signal was at least 1 0
times more valuable to consumers i f converted to cellular telephone
service.
1
The basic allocation dilemma is clear: why force an old regulatory
pattern on a changing world? The 1952 TV allotment was made
before a single movie mogul had dialed up anybody's "girl" from
a car phone to "do lunch," before even the first UHF television
audience had been assembled. How could those planners have
known to what use a particular 6-MHz swath of Los Angeles's
frequency space might best be put in 1992? Is a city teeming with
television stations, cable systems, video cassettes, and the like really
going to value the least-watched UHF signal more highly than
additional access for rush-hour mobile phone users, customers who
today have trouble getting a dial tone? Offhand, I don't know the
answer, and I suspect that those regulators who set out the TV
band allocation in 1952 didn't either.
The logic underlying the Kwerel and Williams policy approach
is sound: don't mandate that a UHF-TV station switch to cellular
telephone service-simply don't interfere with its doing so. Grant
ing license flexibility will force broadcast spectrum users to make
their own self-interested evaluations of where consumer demand
lies and of the cost at which it may realistically be met. It is always
possible to construct arcane theories of market failure, or to stipulate
that certain values unimportant to consumers should be observed
and subsidized by holding consumers hostage in the quarters of
some telecommunications monopolist. Yet the stories of govern
ment failure aren't in the least arcane; they are simply out of elec
toral harm's way.
The new administration can strike a blow for real leadership by
exposing the cost of license inflexibility, inviting in daring new
IOEvan Kwerel and John Williams, "Changing Channels: Voluntary Re-allocation
of UHF Television Spectrum, " FCC, Office of Plans and Policy Working Paper no.
27, November 1992. The estimates of the relatively high value of cellular frequencies
have been reduced in recent months as a result of the assumption that a new
wireless telecom service, PCS, will erode cellular's prices and market power. That
empirical effect actually buffers-on a theoretical basis-the study'S conclusion
supporting voluntary reallocation. The fact is that PCS will be precluded from
entering the wireless market unless voluntary reallocation makes spectrum available
for its use.
142
Telecommunications
telecom entrepreneurs, and allowing the American public to reap
the bountiful rewards of the information age.
Legalizing the Telecommunications Revolution
You want specifics? I'll give you specifics. The most important
spectrum issue before the FCC right now is rulemaking on personal
communications services (PCS) and personal communications net
works (PCN). That marvelous new technology will look very much
like cellular, only better. Using a microcell architecture, digital
transmissions, and ubiquitously portable pocket phones, PCS
appears to be the communications system of the future. It seems
destined to introduce a cornucopia of individual and business ser
vices to dramatically upgrade the social benefits of modern telecom
munications.
That assessment could be right, or it could be wrong. We'll only
find out if we get out of the way of the scores of firms anxious to
risk billions of dollars to prove it correct. But we should be careful
to step aside in a manner that serves the consumer-taxpayer's best
interests. What are they and how can they be served? Let me take
a stab .
Make abundant spectrum available for pes. If 220 MHz are realisti
cally (politically speaking) available, allocate the entire band, not
half of it as the FCC has indicated a willingness to do. Why be
parsimonious? The argument that the commission should keep
a so-called spectrum reserve is technically inaccurate in that the
entire spectrum is a reserve-future uses of the spectrum are
not precluded by sending communications signals through it
today. There is no technical reason to store up a nondepletable
resource, and doing so makes no economic sense. Any spectrum
that fails to deliver consumer services is gone, wasted. Not a
good way to build for the future. Finally, it sets a bad policy
rule: new users must come to the government and ask for permis
sion to deliver new wireless services. Better to get lots of competi
tive private users experimenting with numerous innovations and
thereby speed the introduction of new
.
uses .
Use voluntar reallocation. No spectrum? This is how we create
an economic resource: we take it out of less valued employment.
(In the real economy nothing is created or destroyed, j ust
switched to more highly valued uses. ) Incumbent users of the
143
MARKET LIBERALISM
spectrum should be grandfathered on current assignments and
then given the right to wheel and deal with newcomers. Protests
from incumbents about technical problems and public interest
considerations are most likely just the protectionist squeals of
special interests trying to cut a fatter deal. Let them negotiate in
good faith in private market transactions, not as terrorists who
would hold up social progress.
Maximize license fexibility. PCS will be a broad family of new
telephone services, some of which will look much like the old,
some of which will be quite distinct. We think. No one really
knows. There is no reason to limit newly licensed PCS competi
tors to just those services that sound good to FCC planners today.
Above all, do not narrowly tailor licenses in an attempt to either
( 1) assure success of the newly licensed PCS firms or (2) protect
the revenues of existing wireline and wireless telephone compa
nies. Ensuring the success of new firms means licensing comfort
ably noncompetitive companies whose high prices will easily
cover costs. Protecting incumbents means more high prices for
consumers. Let PCS be an innovative battleground with lots of
dueling technologists discovering what services can be sent via
the magic of digital wireless. Standards are difficult to set in such
an industry. Let the industry do it here, much as has been done
in the personal computer and video cassette recorder industries.
Permit nationwide licenses . The cellular telephone licensing
scheme-two per market in 733 markets-was very funny. But
seriously, folks, for the past decade the marketplace has been
trying to put Humpty Dumpty back together again. Cellular One
(McCaw and Southwestern Bell) is trying to patch a nationwide
network together; all the other major players are working on a
rival. Brokerage fees alone easily amount to over $1 billion, but
the real social cost of partitioning markets so finely is that con
sumers have to wait years to get decent roaming service and
rates. Since the idea of a mobile phone is that one can move
around, it is apparent that nationwide licenses should not be
artificially precluded.
License a suffcient number of competitors. Because an FCC license
will form an airtight barrier to entry (loosening license inflexibility
elsewhere would help to alleviate the problem, though), the
licenSing process should be seen as an antidote. In assigning
14
Telecommunications
licenses to particular private suppliers and by preventing post
assignment mergers (common Fee policy), the agency engages
in a sort of poor man's antitrust regime. It is simple, structural,
and does not involve the endless litigation of antitrust policy in
the unlicensed economy. Here the policy should not be onerous
in its deconcentration requirements; it should allow each compet
itor to easily achieve necessary economies of scale with respect
to spectrum size. But the monopoly profits and high prices atten
dant to the cellular duopoly markets should convince us that
two are not enough.
1
1
Auction licenses. The billions of dollars' worth of licenses that will
have to be awarded will provoke billions of dollars in pure rent
seeking expense if lotteries are employed. That may even prove
somewhat embarrassing to the administration, as "application
mills" advertise lottery applications as get-rich-quick schemes
via federal giveaways. 12 The approach of traditional regulators
has been to toughen requirements for entry into the lotteries so
as to limit them to applicants that are genuinely interested in
being pes providers. Well, that's been tried. America found out
that there were about 400,000 "real" cellular telephone applicants
when, in setting up those lotteries, entrants had to "prove"
that they had the capability and capital to actually be cellular
operators. If lotteries are to be conducted, instead of stiffening
entry requirements (and predictably encouraging even more tal
ent to be wasted on dressing up investors to look like real telecom
munications players), the qualifying criteria should be lowered to
proof of U. S. citizenship. Indeed, a random drawing by Social
Security number for a large number of good-sized pes licenses
would be the ideal allocation scheme: by allowing instant license
resale, a competitive market would be produced with a minimum
of wasted resources.
liThe NTIA's 1991 analysis put urban cellular systems at a market value of about
$80 billion, while physical capital was valued at only $6.7 billion. That is strong
evidence of the existence of market power.
12
The essential problem is that the fly-by-nighters were economically correct: there
was easy money in the cellular lotteries. Michaels and I estimated, for instance,
that there was an expected return of over five to one in the 1988-89 rural license
lotteries. Hazlett and Michaels.
145
MARKET LIBERALISM
Do it fast. Speed turns out to be very important. Every month
the American economy goes without the tremendous new pes
industry is a month wasted by federal policymakers. This valu
able new service helps the macroeconomy and virtually every
microsector you can name (health, manufacturing, education,
communications, transportation, and personal security are just
a few of the easy ones) . But history should alarm us. Although
the cellular telephone licenses were issued between 1982 and
1989 (with a couple dozen rural licenses still in dispute), cellular
telephone technology was actually developed . . . in 1946. Even
being very generous about the causes of delay, the uncontestable
costs associated with the regulatory lag are astounding. In a
1991 study by the National Economic Research Associates, which
conservatively assumes a lO-year delay, FCC policy indecision
cost the U. S. economy over $6 billion.
1
3 Delay a year here, a year
there . . . and pretty soon it gets to b real dead-weight loss.
I3National Economic Research Associates, "Estimate of the Loss to the United
States Caused by the FCC's Delay in Licensing Cellular Telecommunications,"
November 8, 1991. Mines describes the regulation-induced delay in some detail and
implies that it consumed far more than a single decade. Christopher W. Mines,
"Regulation and the Re-Invention of Cellular Telephone Service in the United States
and Great Britain, " Kennedy School of Government, Program on Information
Resources Policy, February 9, 1992.
146
ART
LOMESTlCOLlCY
o. Social Security's Uncertain Future
A. Haeworth Robertson
Social Security is a program of promises-two separate and dis
tinct kinds of promises. One is the promise that specified benefits
will be paid to the retired segment of the population; the other is
that specified taxes will be collected from the working segment of
the population. Benefit promises are made to one generation and
taxation promises to that generation's children.
Those promises are equally important, but, unfortunately, we
have tended to place more emphasis on our promises to the retired
population than to the working population. We have placed more
emphasis on the benefit promises than on the taxation promises.
Under a pay-as-you-go system of benefits based on social ade
quacy instead of individual equity, there is virtually no relationship
between the benefit promises and the taxation promises made to
an individual or to a group.
Some would argue that there is a connection between benefits
and taxes because the system is partially funded in advance. That
is false; the system is not, in reality, advance funded at all. The
government collects more Social Security taxes than are needed to
pay current benefits; it spends the "excess" taxes on other govern
ment programs; and it issues an IOU (Treasury bond) to the Social
Security trust funds, which simply means that the government
intends to collect general revenue in the future to redeem the bonds,
plus interest thereon, when Social Security needs the money to
pay benefits.
In other words, part of our Social Security taxes will be used to
pay for other government programs during the trust fund's "build
up"; and an equivalent amount of general revenue (enhanced by
interest) will be used to pay Social Security benefits during the trust
fund's "liquidation" period.
It takes a fantastic imagination to believe that that process will
strengthen the security of future benefits or that it will reduce the
149
MARKET LIBERALISM
future tax burden (taking into account both general revenue and
payroll taxes) . The present trust funds, and probably the future
trust funds, are mere window dressing that has no economic reality.
There clearly is no advance funding, government rhetoric to the
contrary notwithstanding.
Some would argue that during its working years a particular
generation pays taxes that are equivalent to the benefits it will
receive; that a generation buys and pays for its own benefits. That
is false. Social Security, by its very nature, does not provide an individ
ual or an entire generation with benefits equivalent to taxes paid.
Benefit promises and taxation promises are separate and distinct
promises made to different groups of people, among which there
is a certain amount of overlapping. Therein lies the crux of the
Social Security problem.
Beneft Promises vs. Taxation Promises
What promises have we made, and can we keep them? The latest
reports of the trustees of the Social Security system contain the
projected costs of our benefit promises that are to be financed
primarily by the Social Security payroll tax: the Old-Age, Survivors,
Disability, and Hospital Insurance programs.
The cost is projected to rise from its current level of 14 percent
of covered, taxable payroll to between 26 and 4 percent of that
payroll by the middle of the next century, depending on whether
you accept the "intermediate" or the "pessimistic" projections (see
Figure 8. 1) . No credence whatsoever should be given to the "opti
mistic" projections. The pessimistic projections are the appropriate
ones to use in assessing whether or not we can fulfill our benefit
promises.
What level of taxes have we promised future generations they
must pay to finance those benefits? We have promised the indefinite
continuation of current payroll tax rates-7.65 percent for employ
ees and 7. 65 percent for employers. In addition, general revenue
equivalent to approximately 1 percent of payroll wiII be generated
(principally from taxation of Social Security benefits). Those tax
revenues will be sufficient to finance only 50 to 70 percent (based
on the pessimistic and intermediate projections, respectively) of
the benefit promises we have made to the baby-boom generation.
Some analysts who want to create a false sense of security about
the future of Social Security try to ignore Medicare, an important
150
Social Security
Figure 8. 1
PROJECTED COST OF SOCIAL SECURITY AS A PERCENT AGE OF
TAXABLE PAYROLL
4

44.0%
. .
,

;
.
,

:_

' Assumption
_

. . . . . , l , . . . . . .

. .
.
.

30
. . ... .. . .................. . ......,... . ] . . . .. . . . . ..
TInme
:
' : : Intermediate
'
=Epndnures (Actual)

: Assumption

.
Epnditures (Projete) " .

.23%
::

I

,
,

. .

.

... . . ., . . .... . _ .__ _

: ., . . . . .

_
1 0
. : : . . . . . r:
,
. . . . .

-.. ..... ..

. .@

.
:
1
- :=: ; '
0
1 940 1 95 1 96 1 970 198 199 20Q 20102020 2030 2040 205 206 2070
Calenar Year
NOTE: Tax income includes Old-Age, Survivors, Disability, and Hospital
Insurance taxes and revenues.
component of Social Security's rising future cost. In 1989 the aver
age cash annuity paid to a retired worker and spouse was $922 per
month. The average monthly value of the "medical care annuity"
provided such a couple was $304 for Hospital Insurance benefits
and $200 for Supplementary Medical Insurance benefits. Thus, the
value of the Medicare portion of Social Security was 55 percent of
the value of the cash annuity portion.
I t i s misleading to state that Social Security will be financially
sound well into the future and thus imply that Social Security's
151
MARKET LIBERALISM
currently scheduled taxes will be adequate in the future. That is
clearly not true since an important component of Social Security
taxes is used to finance the Hospital Insurance part of Medicare.
In assessing the adequacy and the financial viability of retirement
benefits to be provided by Social Security to the baby-boom genera
tion, we should consider the medical care annuity as well as the
cash annuity. Even if Medicare is someday separated from what
we now call Social Security, the question of its viability will remain.
In addition, of course, there is the promise to provide Supplemen
tary Medical Insurance benefits-medical services not covered by
Medicare's Hospital Insurance. The taxation promise for SMI is a
little murky. At present approximately 25 percent of the cost of
SMI is covered by "premiums" paid by persons eligible for benefit
protection, and the remaining 75 percent is drawn from general
revenue. Under present law the portion financed by general reve
nue will increase over time.
It would seem that the taxation promise is that taxpayers will
have to pay whatever amount of general revenue is needed in
the future to provide SMI benefits, but taxpayers have not been
informed of that obligation. (In fact, the SMI trustees' reports show
projected future costs for only the next 10 years, but we can project
that the cost of SMI will rise from its current level of 2 percent of
payroll to some 8 to 1 1 percent by mid-21st century. )
Which Promises Will Be Broken?
It is indisputable that some of Social Security's promises will be
broken. The questions are, Which promises, when, how, and for
what group of the population?
From Social Security's financial standpoint, there is little need to
break either benefit promises or taxation promises during the next
10 to 15 years. Social Security's income and outgo will approxi
mately balance during that period.
But beginning in the year 2006, when the first baby boomer
reaches age 60, we shall have to renege. We can reduce benefits
for the baby boomers, or we can increase taxes for the boomers
still working as well as for all of the boomers' children. I submit
that the choices we make will be much more significant and far
reaching than we now envision.
152
Social Security
Break the Taxation Promises
We could break the taxation promises and keep the benefit prom
ises. People could continue to retire in their early 60s.
One of the consequences would be very high Social Security
taxes. There are several well-publicized reasons for the high pro
jected cost of Social Security: the baby boom followed by a baby
bust, longer life expectancies, extraordinary increases in medical
care costs, and the assumption of a continued pattern of retirement
between ages 60 and 65.
In 1930 the remaining life expectancy for a 65-year-old male was
1 1 . 8 years; for a female it was 12. 9 years. In 2030 the remaining
life expectancy at age 65 is projected to be 16. 8 years for a male
and 20. 8 years for a female.
In 1950 there were 16 Social Security taxpayers for every benefit
recipient; today the ratio is about 3. 3 to 1, and in 2030 it will probably
be less than 2 to 1 if present retirement patterns continue. All of
those factors have obvious implications for a pay-as-you-go Social
Security system (see Figure 8. 2) .
Although higher taxes may be a feasible solution, their assess
ment would have a marked effect on the standard of living of both
the working and the retired segments of the population. Workers
would obviously have less discretionary income; there would also
be fewer resources available for improved education, a cleaner envi
ronment, improved health care, a better maintained infrastructure
of roads and bridges, and so forth.
In the future, it is unlikely that a workforce consisting primarily
of people under 65 will be large enough to produce all the goods
and services needed to support the entire population. If those work
ers were able to do so, they would retain such a small proportion
of what they produced, and there would be such a massive redistri
bution of income, that the nation would have moved a long way
if not all the way-toward a socialist economy.
All of those consequences would flow, not from deliberate deci
sions about how to allocate resources, but from
having adopted a social insurance system in the 1930s that effec
tively divides the population into workers and nonworkers,
misrepresenting the nature of the system in order to gain public
acceptance, and thus
153
1 950
1 990
2030
154
1 MI I IIon
Z0 MI I IIon
ZT MI I IIon
Intermediate
Assumption
Pessi mi stic
Assumption
c: Workers Paying Taxes
_ Retired Workers
c: Other Beneficiaries
Social Security
causing the public to consider the system inviolable and not
subject to change to adjust for conditions unforeseen in the 1930s:
a baby boom followed by a baby bust, improved but more costly
medical care, and longer life spans.
Break the Beneft Promises
We could break the benefit promises and keep the taxation prom
ises. Benefits to baby boomers might have to be cut by as much as
50 percent. Obviously, people would not be able to retire as early
as they had hoped and planned.
Because of the nature of Social Security's promises, the conse
quences of breaking them should not be underestimated. The Social
Security program promises a certain level of retirement benefits in
exchange for the payment of taxes during one's working years.
Moreover, the Social Security Administration emphasizes that
Social Security retirement benefits are not sufficient to fully replace
the earnings lost through retirement and encourages workers to
participate in private pension plans and to save and invest on their
own in order to have a total retirement income that will be sufficient
for their needs. If, after several decades of playing by those rules,
workers are abruptly notified that Congress has chosen to reduce
Social Security retirement benefits, they may well be unable to
adjust their own savings and pensions to compensate for the lower
Social Security benefits. Workers may then face the difficult choice
of delaying their retirement (if possible) or adjusting to a lower
standard of living than planned.
In addition to the immediate impact on the retirement plans of
workers and their families, and the loss of public confidence in the
Social Security program, such broken promises could have another
serious ramification-complete loss of confidence in the govern
ment itself. Social Security is probably the last major government
program in which the public still has any significant degree of
confidence.
Without the confidence and support of the public, the institution
of orderly government cannot long survive. If a major default occurs
in the Social Security benefit promises, anarchy may not be far
behind.
Is There a Better Choice?
Is there a better choice than anarchy or socialism? We will proba
bly have a little of each, because we have already waited too long
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to be honest with the public. We have misrepresented the nature
of Social Security and its long-range cost and implications for so
long now that we cannot completely avoid the consequences. We
can, however, minimize the adversity of those consequences with
timely and well-chosen action.
There is no single best solution; the preferred solution depends
on one's objectives and philosophy. But whatever the solution
may be, in order to minimize future turmoil it must have three
characteristics:
1 . It must be decided on and communicated to the public very
soon (i. e. , within the next five years so that the baby boomers
will have time to adjust their retirement plans).
2. It must generally be considered fair, or at least to call for an
"equal sacrifice" by the various segments of the population.
3. It must result in a more complete utilization of the nation's
human resources over each person's life.
The nation should provide an environment in which the capabili
ties of each individual can be utilized effectively, an environment
that fosters meaningful activity, not empty idleness. Both the incen
tive and the opportunity should exist to enable all individuals to
work and produce throughout their lifetimes in a series of endeav
ors compatible with their changing physical and mental abilities.
Government policies should be directed toward those goals, not
toward removal from the active workforce of able-bodied persons
persons who must then be supported by the remaining active
workers.
It will not be easy for the nation to move in the direction of full
utilization of its human resources. The alternative will be continued
high unemployment and underemployment, an ever-increasing
pool of idle "disabled" and "aged" persons, and a total cost to
society that will become increasingly unbearable and will eventually
become Cestructive.
But before we can start developing solutions, more people must
be aware that we have problems. And they must understand the
nature and magnitude of the problems. A better understanding of
Social Security is essential if it is to evolve into a system that will
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Social Security
appropriately meet the needs of the baby-boom generation, as well
as ensuing generations, at a price that future taxpayers will be
willing and able to pay.
157
J. The Learning Revolution
Lewis J. Perelman
The collapse of the Soviet empire is just one of the most dramatic
symptoms of the dawn of the Iew knowledge-age economy. One of
the most critical of the many profound impacts of the technological
revolution is the global obsolescence of traditional education and
training institutions. Prosperity in the new economy depends on
a complete replacement of worn-out public policies that are
intended to subsidize and "save" those institutions. The new policy
paradigm must focus on ( 1) abolishing the wasteful paper chase
for academic credentials and (2) commercializing (not just privatiz
ing) the economy of academia, the biggest and probably the last
great socialist empire on earth.
The New Economy
In the new economy being formed by explosive advances in
information technologies, knowledge has become the crucial factor
of production. Contrary to much of the conventional (and back
ward-looking) wisdom driving most recently proposed economic
strategies, software has displaced manufacturing as the key to
national economic strength, and learning has become the crucial
form of work required for self-reliance and prosperity.
With learning now the indispensable focus of work, entertain
ment, and home life, the attempt to keep learning confined in the
box of the government-controlled empire of school and college
classrooms threatens to be as counterproductive as were political
efforts at the beginning of the 20th century to protect the vast horse
industry against the threat of the automobile.
National economic leadership, security, and prosperity at the
beginning of this century depended on the swift, wholesale replace
ment of the horse-based transportation system by an all-new system
based on the automobile (and shortly thereafter, the airplane) . In
the same way, economic progress in the 21st century will depend
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on the rapid replacement of schools and colleges-a $5-billion
a-year industry in the United States alone-by a new commercial
industry based on the technology I call hyperlearning (HL).
Henry Ford's Model T was not an invention so much as the
integration of a set of technical advances in power plants, rubber
tires, electrical systems, and other components as well as fuel refin
ing, production engineering, employment policies, and marketing
strategies-a total system that changed not just transportation but
the entire fabric of Western society. Similarly, HL represents the
integration of skyrocketing advances in the so-called artificial intelli
gence of computers and robotics, broadband multimedia communi
cations, "hyper" software needed to cope with the resulting infor
mation explosion, and even "brain technology" that is expanding
our understanding of how human and artificial brains work.
"Hypermated" learning loops increasingly form the core of just
about every kind of economically productive activity. The London
Stock Exchange has replaced legions of shouting foor traders with
an automated telecomputing network, following the lead of Ameri
ca's NASDAQ. The most prosperous farmers today spend more
time working with computers than combines. Political rhetoric not
withstanding, factory "jobs" are not coming back: they are bound
to become as productive, and hence as scarce and knowledge
demanding, as farm jobs. General Electric's state-of-the-art light
bulb factory in Virginia employs one-third the number of workers
employed by the factory it replaced-and none ever touches a light
bulb. Each of the few workers employed in Corning Glass's most
modern plants is trained to be able to run every operation in the
factory, not to do a "job." The work is primarily troubleshooting
and managing the software of the automated systems that do the
actual manufacturing.
The HL revolution cannot be brought about by any "reform" or
"restructuring" of schools and colleges, any more than the horse
could be retrained or even genetically rebred to become a car.
"Break-the-mold" schools can't and won't.
Education: A Barrier to Progress
A critical feature of the new world order marked by the collapse
of socialism is that education, once widely viewed as an engine
of prosperity, has become the major barrier to global economic
progress.
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The Learning Revolution
The overeducation of the workforce is one of the major causes of
the economic slump that has plagued the U.S. and other modern
national economies for some three years. Roughly three-quarters
of the thousands of employees being eliminated by major employ
ers such as IBM, General Motors, and TRW are managerial, profes
sional, and technical workers with extensive college and postgradu
ate education. In the present recession, corporate middle managers
have been 2.5 times more likely to become unemployed than the
average worker. In past recessions, laid-off factory workers were
rehired when sales recovered, but the recent rapid growth of white
collar unemployment represents the permanent elimination of jobs.
In the recession of the early 1980s, white-collar employment kept
on growing, and 90 percent of white-collar employees who lost
their jobs were rehired within a few months. In the latest recession,
white-collar employment has declined, and fewer than 25 percent
of the displaced white-collar workers have been able to find new
jobs.
Recent political campaign proposals called for more "investment"
in the U.S. workforce in the form of expanded spending on tradi
tional education and training programs. The rhetoric masked the
reality that the United States currently has the most highly schooled
workforce in its history: from 1970 to 1989, workers with four years
of high school increased from 31 to nearly 39 percent of the work
force, and the proportion of the U.S. workforce with at least four
years of college nearly doubled from less than 11 to over 21 percent.
Fewer than 23 percent, and probably no more than 15 percent, of
U.S. jobs will call for college degrees in the 1990s. With over a
quarter of the workforce planning to earn college diplomas, it is
likely that 10 percent of U.S. college graduates will be unemployed
by the end of the decade, and between a quarter and a half of the
graduates will be underemployed in jobs that do not really require
their degrees.
The ongoing deflation of academic credentials will only be accel
erated by the end of the Cold War. In the wake of the "brain glut"
unleashed by the collapse of the Soviet Union, U.S. companies
such as AT&T, Corning, and Sun Microsystems have been hiring
top Russian scientists and engineers, among the best educated and
most skilled workers in the world, to work in Russia for salaries
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on the order of $60 a month. And some 2 million of America's
own most technically schooled and skilled workers are destined to
become unemployed over the next two years as a result of defense
spending cuts and force reductions.
A prime flaw in the whole educational system is that it was
designed in the midst of the Industrial Revolution of the 19th cen
tury to prepare people for in<ustrial-era jobs. But the kinds of skills
required to work productively in the knowledge age are almost the
opposite of the skills demanded for academic success. And the
message buried in the statistics is that "jobs" for both the over
schooled and the unschooled are fast disappearing. Entrepreneurial
skills are the ones most needed in the new economy, where the
majority of the "workforce" will be made up of contractors, consul
tants, free agents, and traditional business creators and owners.
Yet the competencies needed for successful entrepreneurship are
almost totally ignored by the existing educational and training
system.
Even as the services of the scholastic sector become increasingly
irrelevant to the economic aspirations of the great majority of
Americans, the cost of the obsolete academic bureaucracy continues
to soar. Add the $50-billion-plus that employers spend to educate
employees to the $450-billion annual school and college budget,
and throw in at least another $100 billion a year spent on "hidden"
forms of education (such as conferences and conventions), and the
education sector is virtually tied with the health care sector as the
biggest industry in the u.s. economy.
The upward spiral of costs has been almost as explosive in educa
tion as in health care. Real spending per student in U.S. K-12
schools (discounting inflation) has grown some fve times since the
1950s. In the 1980s real U.S. spending on K-12 schools grew by
nearly a third; spending on colleges grew even more, by about a
half.
Productivity, the key issue that has been neglected by education
and training policies, needs to be the focal point of the new policy
paradigm. Growth in productivity-increasing the amount of
wealth produced by each hour of labor-is the essential measure
of a nation's standard of living and relative "competitiveness."
Weak growth in productivity has been the central symptom of
America's economic malaise for some two decades.
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The Learning Revolution
Poor and declining productivity is the main reason the education
sector has become a barrier and a threat to economic progress in
the modern world. Education as an industry is nearly twice as labor
intensive as is the average U.S. business, and its relative labor
costs are more than twice those of high-tech industries such as
telecommunications. Moreover, while the productivity of other
information-based industries has been advancing smartly, even
explosively, the soaring costs and stagnant output of the education
sector have spelled a steady decline in productivity at least since
the 1950s.
The sheer size of the education sector, America's first or second
biggest industry, thus has been dragging down average growth in
productivity. And education is undermining the national standard
of living even more because, in addition to being a very large
business, it is one that is strategically critical to the growth of a
knowledge-age economy. With the learning enterprise playing the
central economic role in the knowledge age that steel making played
in the industrial age, a weak and declining learning sector is under
cutting the development of nearly every other modern business.
The productivity-focused goals of the new paradigm of national
learning policy that should replace intrusive and irrelevant
"national education goals" can be summarized in four simple
words: More, Better, Faster, and Cheaper. That is, policy needs to
ensure the rapid development of HL systems that enable citizens
of all ages to learn more about everything; to learn better, especially
those things that are relevant to productive work; to learn faster,
with less waste of time; and to do all that at lower and steadily
declining cost.
HL technology already exists and is achieving those productivity
goals in the segments of the national learning enterprise that are
compelled by competitive forces to seek more and better learning
in less time at lower cost-notably, in corporate and military organi
zations. For instance, U.S. corporate and military educators spend
about 300 times more of their instructional budgets than public
schools do on systems based on increasingly advanced computer
and multimedia technology. The reason is that, in the competitive
environments of the marketplace and the battlefeld, learning objec
tives are focused on competency rather than credentials, and there
are powerful rewards for productivity and thus for innovation.
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The Action Plan
The national action plan needed to replace the worn-out and
outdated education establishment with a 21st-century HL industry
has four key strategies.
Decreden tial ize
First, America needs to eliminate the economic value of academic
credentials. Credentialism has been the key barrier that has
thwarted a half century of attempts at educational reform and
restructuring. As long as the public has reason to believe that elite
academic credentials-based on attendance at the "right" institu
tions-are the essential passports to lucrative employment and
other economic opportunities, the public will continue to resist any
reform that gives learning and competency priority over testing
and sorting. As long as public policy continues to presume that
the cognitive needs of the "work-bound" population warrant cate
gorically different, and hence inferior, treatment than those of the
"college-bound" population, expenditures on education will con
tinue to undermine rather than strengthen economic progress.
The economically productive alternative to credentialism is certi
fication of competency. In short, people's opportunity to participate
in employment or entrepreneurship should be based only on what
they know and what they can do. There is simply no job or enter
prise in this economy that truly requires an academic diploma or
degree for successful performance. As Chief Justic Warren Burger
wrote in the landmark civil rights case of Griggs v. Duke Power,
"History is filled with examples of men and women who rendered
highly effective performance without the conventional badges of
accomplishment in terms of certificates, diplomas or degrees."
A broad, even universal, commitment on the part of U.S. employ
ers, as well as financing and other institutions, to eliminate the
currency of diplomas would lead necessarily to a huge demand for
effective tools to assess the know-how of applicants for jobs, small
business loans, and so forth. Sophisticated assessment tools already
exist and are being used by leading employers such as the U.S.
Army, Corning, Allstate, and Toyota. Making competency-based
employment (and other economic access) a universal practice would
spawn the rapid growth of a high-tech, profitable, cost-effective
assessment industry. Funding for that new industry would come
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The Learning Revolution
from some of the hundreds of billions of dollars that would be
saved when tax and tuition payers were freed from paying tribute
to the diploma mills.
There are several steps the new president should take to help
achieve the goal of a diplomaless economy.
Federal Employment and Contracting. As the nation' s biggest
employer, the federal government should demonstrate its commit
ment to decredentialization by reforming its own employment and
contracting practices to eliminate all requirements for and refer
ences to scholastic diplomas and degrees. Military and other federal
agencies already are more advanced than many other employers
in relying on competency-based employment and training proce
dures, so the scope of this reform is not likely to be drastic. Much
of it probably can be achieved by executive order, although some
new legislation may be required to reconcile competency testing
with civil rights law.
"SCANS I. " The Secretary's Commission on Achieving Neces
sary Skills (SCANS), which was convened by Secretary of Labor
Elizabeth Dole and included representatives of a range of American
industries, worked productively from 1990 to 1991 to define a set
of competencies needed for employment in the modern economy,
as well as criteria for assessing those skills. The new administration
should help move the SCANS work from theory to practice by
inviting U. S. employers, either through trade associations or indi
vidually, to join a coalition pledged to implement the kind of compe
tency-based employment practices suggested by SCANS within a
reasonable period of time-say, by January 1, 1995. The coalition
could establish an oversight committee or council to monitor prog
ress and to target regulatory or legal barriers that the government
needs to reduce. The president also might establish, either through
an executive agency or the employer coalition, something like the
Baldrige Award (for quality management) to acknowledge leaders
in competency-based employment.
Civil Rights. The new president should order the Justice Depart
ment to review existing civil rights laws and regulations to deter
mine to what extent employment discrimination based on academic
diplomas may be in violation of the law.
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Assessment Research and Development. Through executive directive
and whatever enabling legislation may be necessary, the new presi
dent should establish a new federal program of research and devel
opment on human performance assessment, aimed at advancing
the cost-effectiveness of the technology needed to measure what
people know and can do in the context of real work requirements.
The program might best be centered in the National Institute of
Standards and Technology (Commerce Department)-with active
collaboration of the Defense Department (e. g. , the Defense
Advanced Research Projects Agency, the Office of Naval Research,
and the Army Research Institute) and the National Science Founda
tion-or in the new Department of Knowledge Resources sug
gested below.
Entrepreneurship. The new president should order that, in all the
above initiatives and others, preparation for and competency at
entrepreneurship should be given priority at least equal to or greater
than that given to employment.
Commercialize
In recent years many politicians, business leaders, and families
have begun to appreciate the essential importance of breaking up
the socialist monopoly of the government-controlled education sys
tem. "Privatization" of public education is much needed and should
be a national goal of the new president. But "school choice" is an
inadequate strategy for achieving the benefits of a market economy
in the learning sector or for unleashing the growth of the strategi
cally crucial HL industry.
In a long list of problems, the primary flaws in the school choice
(including college choice) strategy are vouchers and nonproft organi
zations. Because classroom teaching is technologically and economi
cally obsolete in the HL era, choice in the form of vouchers for
tuition at present-day schools is as irrelevant to hyperlearning as
the choice of horses is to modern transportation. Because the com
mercial profit motive is absolutely indispensable to drive the rapid
technological innovation the HL era demands, choice programs
that merely redistribute public moneys among nonprofit schools
whether government owned, private, or church affiliated-are
bound to be irrelevant and ineffectual .
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The Learning Revolution
Instead, the new administration should be committed to commer
cial privatization of the entire education sector, based on a strategy
of microchoice using the financing mechanism of microvouchers.
To illustrate the idea of microchoice: If our choice of television
channels worked the way school choice is proposed to, changing
channels from HBO to CNN would require unplugging the T set,
taking it back to the store, exchanging it for a different model, and
moving to a new neighborhood. In reality, of course, choosing
among dozens or hundreds of video options requires no effort more
strenuous than pushing a button. Similarly, modern HL technology
can offer the individual even more choices of "teachers" and
"schools" than of cable TV channels. HL's broadband, intelligent,
multimedia systems permit anyone to learn anything, anywhere,
anytime with grade-A results by matching learning resources pre
Cisely with personal needs and learning styles.
Microvouchers that use modern electronic card-account technol
ogy can enable individual families or students to choose specific
learning products and services, not just once a year or once a
semester, but by the week, day, hour, or even second by second.
Unlike vouchers for school or college tuition, microvouchers will
create a true, wide-open, location-free, competitive market for
learning that has the elasticity to efficiently and quickly match
supply and demand.
Over 90 percent of funding for u. s. public education is supplied
by state and local governments, which also have the major policy
making role. Nevertheless, there are several steps the new presi
dent can take to commercialize the government-controlled educa
tion sector and to promote the development of the American HL
industry that must replace it.
Federal Microvouchers. The new president should seek legislation
to merge 90 percent of the existing student loan, Pell grant, Job
Training Partnership Act, Trade Adjustment and Assistance Act,
Job Opportunities and Basic Skills program, Chapters I and II of the
Education Consolidation and Improvement Act, and other federal
education and training funds into a single, means-tested micro
voucher program that eligible families or individuals could draw
on to meet the learning and development needs of people of all
ages. Funds should be allocated directly to households, in propor
tion to individual or family need, to be used for the purchase of
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MARKET LIBERALISM
any service or product that is demonstrably relevant to learning
and development needs. The instrument of expenditure would not
be paper stamps or vouchers but electronic account cards similar
to credit or bank cards. The HL microvoucher program should leave
families free to decide how best to distribute the account resources
between adults and children and generally among the members of
the household. That provision would recognize that the needs of
disadvantaged children in many (perhaps even most) cases may
be served best by immediately improving the economic opportuni
ties and status of the parents, as well as by developing their parent
ing skills.
Family Learning Account. As a complement to the means-tested
microvoucher program, the new administration should consider
adding a tax-exempt saving program. Individuals should be permit
ted to make contributions to Family Learning Accounts (FLAs).
Those contributions, which would be similar to contributions to
Individual Retirement Accounts (IRAs), would be deductible from
taxable income, up to some reasonable level, during the year the
contributions were made. Unlike withdrawals from IRAs, with
drawals from FLAs would be exempt from both penalty and tax as
long as they were expended through the microvoucher program.
And such microvoucher expenditures could be repaid to FLAs (with
interest) without being counted against the annual contribution
limit. Beyond some age limit, provision may be made for FLA funds
to be transferred to estates or pension accounts, with appropriate
treatment of deferred taxes. Another difference from IRAs would
be that FLAs would be designed to serve family rather than just
individual needs. The general concept of the FLA is to encourage
households to gradually replace the direct government grant funds
in micro voucher accounts with tax-favored savings contributions.
Leveraging. Federal funds for education and training represent
only about one-tenth of total public expenditure on those areas.
A federal-only microvoucher program would, therefore, provide
significant benefits only to the most disadvantaged portion of the
U. S. population, although it would give the poor more of the free
dom of choice and access to learning tools that the well-off already
enjoy.
Although most of the economic problem caused by an obsolete,
overfunded public education bureaucracy lies in the domain of state
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The Learning Revolution
and local authorities, the president can use the power of the federal
government to infuence the direction of state policy. Specifically,
the new president should consider making part or full eligibility
for the consolidated federal microvoucher-FLA program dependent
on state and local participation. The precedent for such a policy
exists in a variety of federal transportation, welfare, health, and
other programs. For instance, federal law required states to raise
the legal drinking age to 21 to be eligible for federal highway fund
ing. The new administration should determine whether such a
policy may be necessary, in addition to the oft-cited "bully pulpit,"
to induce states to reconstruct their education budgets and bu
reaucracies along the lines recommended here.
Capitalize
The nearly total absence of investment in research, development,
and implementation of new technology may be the main reason
the education sector is a barrier to the growth of the HL industry
and a brake on our whole economy. While the average U. S. busi
ness spends 2 percent of its annual revenues on R&D, and leading
high-tech companies plow 7 to 20 percent or more of their annual
sales receipts into R&D, the education industry invests less than
0. 1 percent of its revenues in the research and development of
new, improved technology.
The health care sector, which is essentially tied with education
as America's biggest industry, spends about $18 billion annually
on R&D; roughly half of that amount comes from government, and
the other half comes from companies. In contrast, only about $300
million is spent annually in the United States on research and
development of advanced learning technology, and virtually all of
that amount is spent by the Defense Department. Another $2 billion
a year for the development and acquisition of associated training
systems may be hidden in DOD weapons budgets. Defense cut
backs threaten to whither that critical national technology asset,
and currently there is no plan to preserve, much less expand, it.
Equally dismal is the education sector's record on capital invest
ment-money that pays for the acquisition and application of tech
nology to improve the quality of products and the productivity of
operations. The average American business invests about $50,000
in capital for each job. In high-tech industries, such as computers
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MARKET LIBERALISM
or telecommunications, from $100,000 to $1 million needs to be
invested for each worker. In the education sector, total capital
investment per employee is less than $50.
The funding needed to close the yawning technology gap is on
the order of $8 billion to $20 billion a year and should come entirely
from the reallocation of some of the $45 billion now being wasted
annually on the nation's obsolete and bloated education system.
Again, the federal government accounts for only a small fraction
of the total funds spent on public education and training in the
United States. If the technology gap is to be closed by reallocation
from existing expenditures, it follows that most of that money will
have to come from state and local rather than federal sources. This
is an area in which the new president can and should use federal
influence to leverage state policies.
National Institutes of Learning. Part of the 10 percent of existing
federal education and training program funds not applied to the
micro choice program discussed above should be used for challenge
grants to reward states that agree to set aside at least 2 percent of
their total current state (and local) education and training budgets
for HL research and development. The challenge grants might rep
resent a federal supplement of 10 percent or more to state R&D
allocations. The R&D funds should be administered by state Insti
tutes of Learning.
As the states implement the new policy, the state institutes
should form a consortium, which could be called the National
Institutes of Learning, perhaps with the federal government acting
as coordinator. Although government organizations cannot and
should not duplicate the product-development role of commercial
business, the mission of the National Institutes of Learning should
be, from the outset, to realize the ultimate goal of commercialization
of advanced learning (that is, HL) technology.
Commercialization necessarily implies effective cooperation
between government R&D programs and private industry. The
U. S. agricultural research system and the federal Small Business
Innovation Research program are two rather successful models that
might be productively adapted to this new endeavor.
Learning Redevelopment Banks. The remainder of the 10 percent
reserved from current federal education and training funds should
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The Learning Revolution
be used for another matching grant program to induce states to set
aside at least another 3 percent of their total current state (and
local) education and training program budgets to help finance the
reconstruction of the education sector's socialist economy. Educa
tion needs the same kind of major capital investment that other ex
socialist economies need to replace obsolete technology and retrain
managers and workers who have little experience with or under
standing of market operations. Those funds should be administered
by redevelopment banks that, like the World Bank or the European
Bank for Reconstruction and Development, will provide loans and
grants to help replace government-controlled institutions with pri
vate, competitive, profit-seeking enterprises. Those funds and
financial institutions need not and probably should not be perma
nent-a "sunset" provision that would shut them down after no
more than 10 years should be included in their charters. But they
should be given adequate funding and a long enough lifetime to
speed the commercial privatization of the education sector.
Bypass
The huge, century-old Bell Telephone monopoly was forced to
break up a decade ago largely because it was bypassed by new
technologies that enabled consumers to get superior products and
services from other suppliers. Today, "distance learning" technol
ogy-using telecommunications and other media to deliver instruc
tional services and resources from anyone, anywhere to anyone,
anywhere-is well enough established in America to start to topple
the public education monopoly in a similar way. Along with the
variety of private school options, the expansion of distance learning
will increase the ability of learning consumers to bypass the control
of the public school and college bureaucracy, thereby shrinking the
government system's client base and reducing its ability to resist
the kinds of policies called for above.
In general, the new administration should pursue a strategy of
expanding the ability of learning consumers-both families and
businesses-to bypass and abandon the established education sys
tem in favor of budding HL alternatives. That strategy requires
acting swiftly to redistribute consumers, finances, and political
influence from the scholastic institutions of the past to the HL
enterprises of the future.
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Break the Telecommunications Logjam. There is an intimate connec
tion between the creation of the broadband, digital so-called "infor
mation superhighways" needed to form the strategic infrastructure
of the knowledge-age economy, on the one hand, and replacement
of the medieval scholastic establishment by a high-tech HL indus
try, on the other: The more rapidly high-capacity, multimedia net
works are expanded nationally, the sooner they will bypass and
replace academia. And the commercial privatization of the educa
tion sector represents a multi-hundred-billion-dollar market oppor
tunity for private investment to reap the rewards of the information
superhighway system.
Thwarting both developments is an ongoing stalemate among
telephone, cable T, broadcast, newspaper, and other media inter
ests that have been vying for control of the new communications
infrastructure. The new president should act aggressively to end
that gridlock by convening a national "summit" meeting of the
interested parties and pressing them to forge an effective consensus
that can be enacted in federal legislation.
End Direct Institutional Aid. Pending the broad restructuring of
federal program funds into the microchoice program described
above, the new president should take whatever actions may be
necessary to end the allocation of federal funds directly to schools
and colleges for instruction-related purposes (as opposed to
research grants) . The tax exemption of supposedly not-far-profit
institutions also should be ended. The idea is to direct funds to
the greatest extent possible into the hands of consumers rather
than to school and college bureaucracies and to eliminate the tax
subsidies that favor would-be nonprofit over commercial suppliers.
Federal Reorganization. Finally, the new president should use his
authority to reorganize the executive branch to reflect the techno
logical and economic opportunities of the future rather than the
special interests of a fading era. Specifcally, the president should
create a new Department of Knowledge Resources by merging the
Education and Labor departments, the National Science Founda
tion, the Federal Communications Commission, the National Aero
nautics and Space Administration, and part or most of the Depart
ment of Energy's national laboratories. The administration also
should consider including other relevant research- and knowledge
oriented organizations, such as the Commerce Department's
172
The Learning Revolution
National Institute of Standards and Technology, National Oceanic
and Atmospheric Administration, and Census Bureau. The presi
dent also should encourage Congress to revise its committee struc
tures along similar lines.
Conclusion
America was founded by people who had the vision and audacity
to overthrow tradition and to establish an unprecedented political
community, grounded in the radical principles of human liberty
and equality. We have now entered a new era when the fabric of
whole societies is being rewoven around the world. From Berlin
to Vladivostok and from Capetown to Buenos Aires, every major
social structure is subject to reappraisal, redesign, and replacement.
Inevitably, the challenges of the dawning knowledge age will
demand that the most conservative social glue, education, be rein
vented as well. The same HL technology that is driving the over
throw of arthritic bureaucracies holds the key to achieving social
reformation swiftly and productively. America's political legacy,
her technological vitality, and her responsibility as the world's
greatest power all demand that she lead the hyperlearning revolu
tion that promises a new birth of freedom, prosperity, and peace.
1 73
1d. Returning Medicine to the
Marketplace
Michael Tanner
Americans are increasingly coming to believe that there is some
thing seriously wrong with our health care system. Costs are sky
rocketing. Twenty years ago health care was a $42-billion-per-year
industry. Today total U. s. health care spending tops $662 billion,
more than 14 percent of our gross domestic product. Soaring costs
are putting enormous financial pressures on American businesses,
forcing thousands of small businesses to reduce or drop benefits
for their employees. Moreover, health care costs are an increasing
burden to already strained family budgets. And nearly 35 million
Americans lack health insurance.
With the upset victory of Harris Wofford in Pennsylvania's spe
cial Senate election in 1991, health care leaped to the forefront
of America's political agenda. Few issues have sparked as much
discussion and debate. In 1992 alone, Congress considered more
than 100 bills on health care. They ranged from Z pages long to
more than 200 pages. The Bush administration released a 94-page
outline of its health care reform program. Bill Clinton countered
with a health care plan of his own. And nearly every think tank
with a word processor contributed a proposal.
Despite all the noise, there has been little constructive action in
Washington. Some think the answer is to force all Americans into
a socialized, government-run, tax-funded health care bureaucracy,
but only solutions that build on a free market in health care will
ultimately be successful in controlling costs and increasing access
to care. Government involvement in health care has been steadily
increasing for 30 years, with disastrous results. It is time to seek
solutions in a different direction, time to look to the power of the
free market.
The idea that America has a free-market health care system is
little more than a myth. America does have a health care system
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MARKET LIBERALISM
that is largely privately owned, but government intervention has
removed market mechanisms from the health care equation. Myriad
federal and state regulations, largely designed to protect powerful
special interests, restrict both the provision and the purchase of
health care services. Those regulations are a significant factor in
driving up health care costs and reducing access to health care,
and they may even be harming the quality of care.
In addition, government tax policies have worked to remove
the consumer from health care decisionmaking. By encouraging
employer-provided coverage to the detriment of individually pur
chased coverage or out-of-pocket payment, or both, our tax policy
increases the trend toward divorcing the health care consumer
from the payor of health care costs. As a result, most health care
consumers no longer pay for their health care. On average, for
every dollar of health care services purchased, 76 cents is paid by
someone other than the consumer who purchased it. That means
that consumers have little incentive to question costs and every
incentive to demand more services. Government itself has also
increasingly become a source of health care payment, with predict
able increases in both the demand for and the price of services.
Despite the record of government failure, too many politicians
think the answer to our health care problems is to force all Ameri
cans into a socialized, government-run, tax-funded health care
bureaucracy. While Europe and Canada are searching for ways to
restore market mechanisms to their national health care systems,
America is in serious danger of adopting a health care system that
will limit patient choice and ration the availability of care but do
nothing to hold down health care costs.
Such a system would come at enormous cost to American taxpay
ers. Even supporters of national health care admit that such a
system would require $60 billion in new taxes. However, most
economists put the cost much higher, possibly as high as $339
billion in additional taxes. Let me give you an idea of what that
would mean to you as taxpayers. Raising an additional $339 billion
would require one of three things: a 15 percent payroll tax on all
businesses, a 10 percent national sales tax, or a 14-percentage-point
increase in income tax rates. 1
IAldona Robbins and Gary Robbins, What a Canadian-Style Health Care System
Would Cost U. S. Employers and Employees (Dallas: National Center for Policy Analysis,
February 1990).
1 76
Health Care
For all the new tax money, we would buy surprisingly little health
care. The one common characteristic of all national health care
systems is a shortage of health care services. For example, in Great
Britain, a country with a population of only 55 million, more than
800,000 people are waiting for surgery. In New Zealand, a country
with a population of just 3 million, the number waiting now exceeds
50,000. In Canada the wait for hip replacement surgery is nearly
10 months; for a mammogram, 2. 5 months; for a pap smear, 5
months. Surgeons in Canada report that heart surgery patients are
in greater danger of dying on the waiting list than on the operating
table. 2 According to Alice Baumgart, president of the Canadian
Nurses Association, emergency rooms are so overcrowded that
patients awaiting treatment frequently line the corridors.
Let's put things in human terms with a short story that illustrates
what this country could be facing. Joel Bondy was a two-year-old
child with a serious congenital heart defect that urgently needed
surgery. It was a serious operation, but one that was performed
many times each day in hospitals across the United States. Unfortu
nately, Joel did not live in this country. He lived in Canada, where
the country's national health care system has resulted in a severe
shortage of cardiac care facilities. Canada has only 1 1 open-heart
surgery facilities to serve the entire country. The United States
has 793.
Joel's operation was repeatedly postponed as more critical cases
preempted the available facilities. Alarmed at their son's deteriorat
ing condition, Joel's parents arranged for him to be operated on in
Detroit. Embarrassed by the media coverage of Joel's situation,
Canadian authorities told the Bondys that, if they would stay in
Canada, Joel would be moved to the top of the list and could have
his surgery immediately. Joel was taken on a four-hour ambulance
ride to a hospital equipped for the procedure, but there was no
bed available. The family had to spend the night in a hotel. Joel
Bondy died the next day.
National health care systems do not control the rising cost of
health care. Proponents of national health care make much of
reported differences in the proportion of GDP spent on health care
2
John Goodman and Gerald Musgrave, 20 Myths about National Health Insurance
(Dallas: National Center for Policy Analysis, 1992).
1 77
MARKET LIBERALISM
by Canada and the United States. It is true that Canada spends
only about 9 percent of GOP on health care, while U. S. costs have
skyrocketed to more than 14 percent of GOP. However, such com
parisons are seriously misleading.
Between 1967 and 1987, the Canadian GOP grew at nearly double
the rate at which the GOP of the United States grew. Therefore,
any comparison of health spending should be adjusted to compen
sate for the differing rates of economic growth. Additional adjust
ments should be made for such factors as population growth; gen
eral infation; currency exchange rates; the larger U. S. elderly popu
lation (the elderly require more, and more expensive, health care);
higher U. S. rates of violent crime, poverty, AIDS, and teen preg
nancy; and greater U. S. investment in research and development.
When all such factors are taken into account, Canadian health
spending is virtually identical to that of the United States and has
actually been rising faster over the last several years. 3
National health care is not particularly efficient. Certainly, there
are many inefficiencies in the American health care system, such
as too much waste and too much paperwork, but socialized medi
cine has its own inefficiencies. For example, Canadian health care
has a tremendous bias in favor of hospitalization. In this country
outpatient procedures now outnumber inpatient ones. In Canada
patients still go into the hospital for procedures that are done on
an outpatient basis in the United States. The average Canadian
who goes into the hospital is less sick than the average American
hospital patient but stays in the hospital almost twice as long.
Canadian hospitals are increasingly being used as glorified nurs
ing homes. There are several reasons for that. One is that Canada
has never developed a good system of hore care. Another is that
from a hospital administrator's point of view it makes sense to fill
the hospital with patients who are essentially using the hospital's
hotel functions, who need little more than meals and to have their
beds changed. After all, a Canadian hospital administrator's num
ber-one concern is staying under his budget cap, and nursing-hore
patients are a lot cheaper to care for than are people in intensive
care. The result is that at a time when people are dying for lack of
178
Health Care
a hospital bed, 25 percent of all the hospital beds in Ontario are
being used for nursing-home care.
If socialized medicine will not solve our health care problems,
what will? Logic, economics, and history show that the only reforms
likely to have a significant impact on America's health care problems
are those that draw on the strength of the free market.
Deregulate the Health Care Industry
There should be a thorough examination of the extent to which
government policies are responsible for rising health care costs and
the unavailability of health care services. We can help lower health
care costs and expand health care access by taking immediate steps
to deregulate the health care industry, including eliminating man
dated benefits, repealing certificate-of-need programs, and expand
ing the scope of practice for nonphysician health professionals.
For example, having decided that people are not smart enough
to choose their own health insurance benefits, all states have laws
that mandate that all health insurance contracts in the state provide
coverage of specific disabilities or diseases and specific health care
services. Those mandates add Significantly to the cost of health
insurance.
Most people without health insurance are employed or are
dependents of employees. Nearly two-thirds of those people work
for businesses with fewer than 100 employees, and nearly half work
for businesses with fewer than 25 employees. Surveys of small
businesses have repeatedly shown that the cost of health insurance
is the primary reason those businesses do not offer health benefits.
By making insurance more expensive, mandated benefits contrib
ute directly to the number of uninsured.
In addition, the majority of states continues to maintain regula
tory restrictions on health care services, such as certificate-of-need
requirements, that act as a barrier to competition. CON regulations
say that if you want to build a new hospital, or buy a new piece
of medical equipment, or offer a new type of medical service, you
must first get permission from the government.
Certificates of need are based on the bizarre economic theory
that greater supply and increased competition will lead to higher
prices. However, studies have repeatedly demonstrated that CON
programs not only fail to contain costs; they may actually lead to
1 79
MARKET LIBERALISM
increased costs, while limiting the availability of medical services,
particularly in rural areas. The Federal Trade Commission has con
cluded that, nationally, "hospital costs would decline by $1 . 3 billion
per year if states would deregulate their CON programs.
,,
4
We also need to rethink our medical licensing laws. Studies have
repeatedly shown that qualified midlevel non physician prac
titioners can perform many medical services traditionally per
formed by physicians. Yet the medical profession has consistently
used licensure and other regulatory restrictions to limit competi
tion. The result has almost inevitably been higher prices for con
sumers. For example, 37 states continue to outlaw the practice of
midwifery. In most states nurse practitioners cannot treat a patient
without direct phYSician supervision. Chiropractors cannot order
blood tests or CAT scans. Nurses, psychologists, pharmacists, and
other practitioners cannot prescribe even the most basic medica
tions.
Recently, in Georgia, the legislature accidentally almost outlawed
most of the practice of nursing. In the final moments of the 1992
session, the legislators were debating a proposal to prohibit the
practice of dentistry without a license, a bill designed to keep dental
hygienists from cleaning teeth. At the request of ophthalmologists
who were attempting to prohibit laser eye surgery by optometrists,
the bill was amended to prohibit anyone except licensed physicians,
veterinarians, podiatrists, and dentists from performing "any sur
gery, operation, or invasive procedure in which human or animal
tissue is cut, pierced or otherwise altered. "s Since routine injections
pierce the skin, nurses would have been prohibited from giving
injections, drawing blood, or starting intravenous fluids. Medical
care in Georgia was nearly brought to a halt. Fortunately, a judge
has issued an injunction against enforcement of the law until it can
be amended.
The problem, however, goes far beyond one misguided piece of
legislation. The blame lies with a process whereby, as the Atlanta
40. Sherman, The Efect of State Certifcate-of-Need LAws on Hospital Costs: An Economic
Policy Analysis, Federal Trade Commission, January 1988.
s
"Nurses Protest Aid Curb," Gwinnett (Ga. ) Oaily News, May 28, 1992.
180
Health Care
Constitution noted, "medical care professionals are constantly turn
ing to the legislature to protect their economic interests, usually
from the incursions of other health care professionals. "
6
Medicare and Medicaid reimbursement regulations are also a
significantfactor in driving up hospital costs. For example, Medi
care rules require hospitals to provide 24-hour nursing service,
furnished or supervised by a registered nurse in each department
or unit of the facility. Medicare also requires hospitals to use only
licensed laboratory and radiological technicians. Medicare even
requires hospitals to have a full-time director of food and dietary
services. Alternatives to hospitals, such as rural health clinics and
community health centers, must also meet stringent administrative
and staffing requirements under Medicare and Medicaid rules.
Sometimes it appears that the government simply can't tolerate
success. For example, one very positive trend in health care has
been the move toward outpatient surgery. The proportion of opera
tions performed on an outpatient basis has been increasing at a
remarkable rate since 1980. And in 1990, for the first time, the
number of outpatient surgical procedures constituted a majority of
all surgeries. It is estimated that by the end of the century, 6S to
70 percent of all surgery will be performed on an outpatient basis. 7
That should be good news. Outpatient treatment is far less costly
than hospitalization. Therefore, a move toward outpatient surgery
will help reduce overall health care costs. In addition, because an
increasing number of surgical procedures are being performed at
nonhospital surgical clinics, there may be an important opportunity
to expand access in areas-such as rural communities-that do not
have full-blown hospitals. But Congress appears to be ready to kill
the golden goose, by requiring extensive new licensing, accredita
tion, training, and reimbursement regulations that will certainly
slow, if not reverse, that trend.
Further, federal and state tax laws prohibit health care facilities
from participating in cooperatives and other arrangements to pro
vide less expensive cost-management, laundry, and housekeeping
services. Other regulations that increase health care costs include
6"General Assembly'S Bad Medicine," Atlanta Constitution, May 30, 1992.
7"Outpatient Surgery on the Rise: Regulation Doesn't Keep Pace," Ne York
Times, July 1, 1992.
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MARKET LIBERALISM
recent rules by the Occupational Safety and Health Administration
and the Health Care Financing Administration governing proce
dures for clinical laboratories. The costs of the paperwork burden
of and compliance with those new regulations, which cover such
critical issues as where a doctor may hang a lab coat, are estimated
to be as high as $40,000 annually for each laboratory. It is expected
that as many as 4,000 small independent laboratories will be put
out of business and the cost of lab tests significantly increased.
Abolish the Food and Drug Administration
One of the most destructive of all federal government agencies
is the Food and Drug Administration (FDA). The mission of the
FDA is ostensibly to protect the public from unsafe or ineffective
medications (and foods, of course) . However, in reality, the FDA
has provided little additional public protection but has driven up
health care costs and deprived millions of the health care treatment
they need.
It now costs more than $231 million to bring a new drug through
discovery, clinical testing, development, and FDA approval, an
increase of 327 percent since 1976. It also takes approximately 12
years for a new drug to reach the market. A substantial portion
of that time and money is the result of the FDA approval process.
Some studies have indicated that the FDA approval process dou
bles the cost of developing a new drug. 9 That cost, of course, is
passed along in the form of higher prices to consumers. In addition,
the high cost of the approval process acts as a barrier to entry,
benefiting large pharmaceutical companies by preventing competi
tion from smaller firms that have limited capital resources.
Even more tragic is the loss of human life that results from delays
caused by the FDA approval process. For example, during the
lO-year delay in allowing propranolol (the first widely used beta
blocker for treatment of angina and hypertension) to be marketed
in the United States, approximately 100, 000 people died because
8Pharmaceutical Manufacturers Association, Good Medicine: A Report on the Status
of Pharmaceutical Research (Washington: PMA, 1992), pp. 8-10, citing figures by
Joseph DiMasi, Tufts University, 1990.
9Samuel Kazman, "Deadly Overcaution: The FDA's Approval Process," Journal
of Regulation and Social Costs, September 1990.
182
Health Care
the drug was unavailable. And, according to George Hitchings, co
winner of the 1988 Nobel Prize in medicine, the FDA delay in
approving the anti-bacterial drug Sepra cost more than 80, 000
lives.
1
In addition, the FDA places restrictions and qualifications on the
advertising of pharmaceutical products; those restrictions have the
effect of preventing consumers from having all the information
necessary to make fully informed medical decisions. For example,
the FDA has forbidden aspirin manufacturers to advertise its bene
fits in preventing heart attacks.
Now, the FDA is attempting to expand its reach, seeking to
extend its authority to cover such items as vitamins and herbal
remedies. The agency is also seeking broader subpoena, seizure,
and surveillance powers to enforce existing regulations.
The FDA is clearly an unnecessary burden to the American health
care system. There is no evidence that the agency offers the Ameri
can people any real protection. Ideally, the FDA should be elimi
nated. That may be politically unachievable, but certainly the size
and power of that dangerous agency should be restricted, not
expanded. Several alternatives exist. For instance, the FDA's veto
power over drugs could be changed to a system of certification.
The agency would continue to review the safety and efficacy of
drugs, but unapproved drugs-clearly labeled as such-would be
available to individuals who chose to use them. Even better would
be the rise of a private-sector organization to provide certification,
much as the Underwriters Laboratory certifies electrical appliances,
which would eliminate the government's role altogether. If the
FDA were not entirely eliminated, it could return to its pre-1962
mission of evaluating only the safety of new drugs. Issues of efficacy
could be left to the marketplace. Lesser steps would include acceler
ating the approval process, as proposed by the Bush administration;
allowing the use of overseas safety data; and privatizing the new
drug application review process.
Restructure Tax Policy
If we are serious about expanding access to health care for unin
sured Americans, one of the most important reforms is to change tax
10 Arthur D. Little, Inc. , Cost-Efectiveness of Pharmaceutical P/.Beta-Blocker Reduction
of Mortality and Reinfarction Rate in Survivors of Myocardial Infarction: A Cost-Beneft
Study, 198.
183
MARKET LIBERALISM
laws that discriminate against people who do not have employer
provided health insurance. In addition to expanding health care
access, such tax changes would (1) establish a basic fairness in
government policy-giving the same tax break to the waitress who
has to buy her own health insurance that we are currently giving
to the well-paid executives of wealthy corporations-and (2) hold
down overall health care costs by increasing consumer involvement
in the health care marketplace.
Current federal and state tax laws exclude from taxable wages
the cost of health insurance provided by an employer. Therefore,
a vast majority of Americans, those who receive health insurance
through their employers, do not pay federal, state, or Social Security
taxes on the value of their policies. Moreover, employers can deduct
the full premium cost as a business expense. Employers do not
even pay Social Security payroll taxes on those benefits. In short,
the entire cost of employer-provided insurance is paid for with
before-tax dollars.
.
However, those Americans not fortunate enough to receive
employer-provided health insurance face entirely different tax laws.
For example, self-employed individuals and their families may
deduct only ZD percent of the cost of health insurance. In addition,
self-employed individuals must pay Social Security taxes on money
used to purchase health insurance. Part-time workers, students, the
unemployed, and everyone else not receiving employer-provided
health insurance-including most employees of small businesses
are unable to deduct any of the cost of health insurance.
That difference in tax treatment creates a disparity that effectively
doubles the cost of health insurance for people who must purchase
their own. For example, the family of a self-employed person
who earns $35,000 per year, has to pay federal and state taxes with
only a 25 percent deduction, and has to pay Social Security taxes
must earn $7,075 to pay for a $4,000 health insurance policy. A
person working for a small business that offers no health insurance
would have to earn $8,214 to pay for a $4,000 policy.
The results of that inequity can be clearly seen. Those workers
who must use after-tax dollars to purchase health insurance are 24
times more likely to be uninsured than are those who are eligible
for tax-free employer-provided coverage. Significantly, the poor
and minorities, who are less likely to have employer-provided
184
Health Care
insurance, are the most likely to be left without access to health
insurance Thus, the perverse impact of our tax policies is to subsi
dize the purchase of health insurance by the most affluent and to
penalize those less well off.
Our tax policies also have an adverse impact on health care prices.
By encouraging employer-provided coverage t o the detriment of
individually purchased coverage or out-of-pocket payment, our
tax policy increases the trend toward divorcing the health care
consumer from payment of health care costs.
Establishing tax equity would encourage health care consumers
to become more involved in the health care system. Individuals
who purchase their own insurance are more likely to shop around
for the best deal. And individuals who purchase health care out
of-pocket are much more likely to make cost-conscious health care
decisions.
It would take only a relatively simple reform to solve the problem.
We should enact legislation making the purchase of individual
health insurance and out-of-pocket expenditures for health care
fully tax deductible.
Establish Individual Medical Accounts
Another proposal to return consumers to the center of the health
care equation is individual medical accounts (lMAs), also known
as Medical IRAs or Medi-Saver Accounts. Individuals would be
exempted from taxes on money deposited in Medical IRAs, in the
same way they currently pay no taxes on deposits to IRAs. Money
could be withdrawn without penalty to pay medical expenses.
With such a program in place, employers could be expected to
change the way they provide insurance. Rather than continuing to
provide high-cost insurance benefits, with low deductibles and
extensive benefits, employers would provide each employee with
an annual allowance of perhaps $2,000, which the employee could
deposit in an IMA. For medical expenses in excess of the $2,000,
the employer would continue to provide health insurance, but such
catastrophic coverage would be relatively inexpensive.
The individual would be responsible for paying his own health
care expenses under $2,000, using funds from his IMA. (It should
be noted that less than 12. 5 percent of all insured individuals have
185
MARKET LIBERALISM
annual claims in excess of $2,000. )1 1 Unspent money in the account
would accumulate and belong to the account holder. Before age
65, there would be a penalty applied to withdrawals for other than
health care expenditures.
IMAs would have six major advantages. First, they would be
particularly beneficial to low-income employees. Most current
health insurance policies have low deductibles, often $100, which
can cause hardships for those with little discretionary income.
Deductibles offer a perverse incentive for low-income workers.
They are often forced to forgo preventive care or early intervention
because they can't afford the deductible. Yet once the deductible
is met, there is no incentive not to incur additional, perhaps unnec
essary, expenses. With an IMA, the incentive is to spend wisely
throughout the year, rather than to punish the first expenditure of
the year.
Second, IMAs would be completely portable. One of the most
serious problems of our current health care system is that insurance
is so closely linked with employment. That means that an individual
who loses his job or changes jobs is in danger of losing his insur
ance. Half of the 35 million Americans estimated to be without
health insurance at any given time are uninsured for four months
or less, and only 15 percent are uninsured for more than two years.
12
With an IMA, those individuals would continue to have funds
available to pay for health care during changes or temporary inter
ruptions in employment.
Self-employed individuals would also benefit. Currently, lack of
health insurance is 10 times greater among the self-employed than
it is among those who work for others. 13 A medical IRA would
allow the self-employed to receive a substantial tax break for saving
for their health care.
I I Based on claims experience in Chicago, one of the nation's highest cost areas.
In more typical areas, only about 9 percent of claims exceed $2,00. From claims
distribution analyses by Tilinghast Corporation.
1
2
Katherine Swartz and Timothy McBride, Spells without Health Insurance: Distribu
tions of Durations and Their Link to Point-in-Time Estimates of the Uninsured (Washington:
Blue Cross and Blue Shield, 1990).
13Health Care Solutions for America, Federal Tax Policy and the Uninsured: How
U. S. Tax Laws Deny I0 Million Americans Access to Health Insurance (Washington:
HCSA, 1992).
186
Health Care
Third, IMAs would give individuals greater flexibility in the types
of health care they could purchase. Such items as prescription
drugs, dental care, and eyeglasses are frequently not covered by
traditional employer-provided health benefit plans. Likewise, most
employer plans do not cover nontraditional health care profeSSion
als such as chiropractors and naturopaths. But an individual could
use his IMA to pay for such services.
Fourth, there would be no administrative overhead costs for
expenses paid out of IMAs. That would reduce both the overall
cost of health care and the paperwork burden on doctors. The
administrative costs for private insurance average 1 1 to 12 percent
. of premiums. It has been estimated that payment of medical bills
with funds from IMAs could reduce administrative costs to 1 to 2
percent. 14
Fifth, IMAs would increase America's savings rate and thus have
a positive overall effect on the economy, and finally and most
important, IMAs would establish an incentive for consumers to act
responsibly in making health care decisions.
Privatize Medicaid and Medicare
The current Medicaid and Medicare systems have dearly failed.
Costs are skyrocketing. Medicare costs have increased to the point
where the systems are in serious jeopardy. Medicare Part A, which
primarily pays for hospital care and services, is projected to be
unable to meet its financial requirements by the year 2005. It is
estimated that to restore the fund's financial stability will require
increasing the Medicare payroll tax from 2. 9 percent to at least 6. 5
percent. Medicare Part B, which pays for physicians' services, is
in no better financial shape. General revenue contributions to Medi
care Part B may increase 300 percent by the end of the century.
And the premium contribution by the elderly may increase by a
similar percentage. Medicaid is in much the same situation. The
state share of the joint federal-state program is growing twice as
fast as overall state spending. Some estimates indicate that state
spending on Medicaid could increase a phenomenal 480 percent
1
4
Mackinac Center for Public Policy, "Health Care: Solving the Administrative
Cost Question," June 8, 1992.
'`IJbb Annual Report of the Board of Trustees of the Federal Old-Age and Survivors
Insurance and Disability Insurance Trust Funds, May 1, 1988, appendix F.
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MARKET LIBERALISM
by the year 2000. The federal share of the program is growing even
faster.
Furthermore, patients are receiving second-rate care. Studies
have shown that Medicare and Medicaid recipients have higher
mortality rates than patients with private insurance. And providers
are being shortchanged. Both Medicare and Medicaid reimburse
providers at a rate well below the actual cost of procedures. As a
result, fewer and fewer providers are willing to participate in the
programs. Those who do pass along their costs to patients with
private health insurance, a practice known as cost shifting.
The time is ripe for drastic reform. The federal government
should begin to restructure the system to give Medicaid and Medi
care recipients more flexibility to obtain private health insurance
that meets their individual needs. As much as possible, responsibil
ity for care of the poor and the elderly should be moved from the
public to the private sector. 16
Conclusion
It has long been noted that the Chinese character for "crisis" is
the same as the character for "opportunity. " Clearly, America's
health care system is in crisis. But we also have a unique window
of opportunity to reform our health care system in a way that will
guarantee that American health care will continue to be the best
in the world.
The only reforms that are likely to have a significant impact on
America's health care problems are those that draw on the strength
of the free market. By developing a market-oriented strategy that
draws on the strengths of competition and consumer choice, we
will reduce health care costs and extend access to care.
Only a comprehensive market-based program will take America's
health care system off the critical list. However, we must act quickly.
If we do not seize this opportunity to establish free-market health
care reforms, those who favor increased government intervention
will surely fill the vacuum. That would be disastrous for the future
of health care in America.
16For a discussion of options for privatizing Medicare and Medicaid, see John C.
Goodman and Gerald L. Musgrave, Patient Power: Solving America's Health Care Crisis
(Washington: Cato Institute, 1992). See also Michael Tanner, "Medicaid Reform:
Giving Georgia's Poor a Choice," Georgia Public Policy Foundation, February 1992.
188
1 1 . Reviving the Inner City
David Boaz
America's most difficult problem in the 1990s is not a military
threat, nor the overhyped environmental problem, nor the deficit,
nor even two decades of slow economic growth. It is the interrelated
ills of race, poverty, crime, and the underclass. It is millions of
Americans afraid to leave their homes at night; millions of Ameri
cans (some of them the same people) who feel permanently shut
out of the mainstream of society; racial tensions and even racial
hatreds on the rise at a time when they should be disappearing.
The New Yorker had it right in its May 11, 1992, "Talk of the
Town":
Either we can start to seriously confront the plight of our
inner cities, and treat it as the national emergency we all
know that it has become . . . [or] we can ignore the problem,
and continue to humiliate and dehumanize the residents of
our inner cities, and try to contain their rage by relying
more and more heavily on police intervention and on the
prison system.
None of us can fail to be moved by the searing images of the
inner city: the pregnant children, the fatherless boys, the squalid
tenements, the police sirens, the law-abiding folk cowering in fear,
the desolation, the resentment, the despair.
To seriously confront that emergency, we must first understand
the nature of the problem: Is the root issue racism, or poverty, or
welfare, or the collapse of moral and family values? Or all of the
above? Whatever our decision, it is clear that we can no longer
ignore the issue. The Los Angeles riots sent a wake-up call to
Americans: something is dreadfully wrong in our inner cities, and
we will not have a peaceful or just society until we deal with this
tangled web of problems.
As usual in our political debates, the right and the left are talking
past each other with increasingly irrelevant arguments. On the left,
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MARKET LIBERALISM
we constantly hear the demand for more money. liThe poor have
been abandoned, we need a Marshall Plan for the cities, the rich
get richer and the poor get poorer. " But if government money
could solve the problems of the urban poor, surely the poor would
be drinking champagne toasts by now. From 1980 to 1990 per capita
spending in cities with populations over 1 million rose from $1, 748
to $2,283 (in constant 1990 dollars)-a real increase of 31 percent.
For cities of 500,000 to 1 million, spending rose from $1, 225 to
$1, 498-a 22 percent real increase. Spending on poverty reached
$226 billion in 1990, or five times the real amount in 1964, when
the War on Poverty got under way-yet the poverty rate, which
was falling dramatically before the War on Poverty, has changed
little in the past 25 years. Money is not the root of America's poverty
problem.
Those on the left also tell us that racism is the biggest problem
facing black Americans. Racism exists, of course, but can it really
be more widespread today than it was 30 years ago? Public places
are far more integrated than they were before the civil rights revolu
tion; two-income black families have made dramatic income gains
over the past two decades; the two highest paid entertainers in
America are black; immigrants of all colors (including those from
Africa) still find America a land of opportunity; schools, colleges,
and businesses practice affirmative action; a black governor has
been elected in the capital of the Confederacy, and a black woman
has been elected to the Senate from America's most representative
large state, which is 78 percent white. No society in the world has
eliminated racial prejudice, but it stretches credulity to blame the
problems of the black poor in America on racism.
There are mirror images of those errors on the right. Conserva
tives say that poverty isn't a problem any more because, after all,
the poor get lots of government benefits. Now, there is a serious
point to be made here: There is virtually no grinding material pov-
.
erty in the United States. In 1990 the real per capita expenditures
of the one-fifth of the U. S. population with the lowest incomes
exceeded the per capita income of the average American household
in 1960. The average American poor person (as defined by the
Census Bureau's annual report on poverty) has twice as much living
space as the average Japanese citizen and more than the average
West European. Most poor households own a car, and almost half
190
The Inner City
have air conditioning. 1 But the conservative argument ignores the
basic point. To be dependent on government handouts, to live in
government housing, to be subjected to the indignities of the social
services industry is poverty. The problem is not that people are
starving, it is that for whatever reason millions of Americans do
not participate in the economy, do not achieve the satisfaction
of providing for themselves and their families. It is callous and
disingenuous to dismiss their plight as "not really poverty. "
Conservatives rightly reject the notion that racism i s the source
of blacks' problems in America. But they go too far when they
respond: "We've outlawed discrimination, instituted affirmative
action, and spent $2. 5 trillion on poverty. Why can't blacks make
it in America?" They ignore the very real crimes that white
America-or at least the U.s. government-has committed against
blacks. First, the government ignored its own principles to hold
blacks in chattel slavery. Then, it passed Jim Crow laws to prevent
blacks from succeeding in the post-Civil War marketplace. Then,
when it finally repealed the Jim Crow laws, it created a welfare
state that ensnared many blacks, trapping them in neighborhoods
with lousy government schools and terrifying crime rates. One
hundred twenty-fve years after the Thirteenth Amendment, mil
lions of blacks are still on a plantation-given money by a white
master and subject to his rules.
Understanding the Problem
So if liberals and conservatives are both wrong, how should
we understand the roots of our urban problems? First, we should
acknowledge that educated, affluent whites have created most of
the conditions we now deplore, albeit often with the best of inten
tions. Second, we should understand just how white elites have
gone astray.
Over the past 70 years or so, white elites-notably legislators
and j udges-have shown a declining respect for the rules of prop
erty and contract. Legislators have taken more and more of our
l
Robert Rector, "America's Poverty Myth," Wall Street Journal, September 3, 1992;
Robert Rector, "Perplexities of the Poverty Data," Washington Times, September 8,
1992.
191
MARKET LIBERALISM
income in taxes and circumscribed property rights through regula
tions aimed at securing everything from low-cost housing to pan
oramic views. Judges have not only upheld those legislative deci
sions, ignoring provisions of the U. S. Constitution that protect
property rights; they have also voided contracts that they thought
reflected "unequal bargaining power" or that otherwise were not
in "the public interest. "
With property and contract getting less respect at the top of
society, is it any wonder that such attitudes trickle down through
society? In courses on "values clarification, " schools teach children
that honesty is an interesting idea, not a moral standard; resume
fraud seems to be rampant; 2 percent of the merchandise in Ameri
can stores is stolen; and newspapers report an increase in the num
ber of people who buy expensive clothes, wear them once to a
party, and then return them to the store. Smokers blame cigarette
companies for their tobacco-induced illnesses, while high school
students who cheat on the SAT blame a materialistic society. We
can and should deplore the irresponsibility and dishonesty of indi
viduals, but we should recognize that they are reflecting a message
that comes from the highest authorities.
The essence of that message is that it is appropriate to transfer
goods from the person who earned them to another person who
did not, and that people need not live up to the contracts they
make. The elites who began that shift in traditional values may
have thought it could be contained-that it would be carried out
carefully by thoughtful judges and legislators-but it seems likely
that the decline in respect for property and contract, the growing
irresponsibility and dishonesty, is partly responsible for the bur
glaries, car-jackings, and murders that now terrify urban residents.
The perpetrators of many of those crimes may unconsciously
believe-and some looters in the Los Angeles riots came close to
saying explicitly-that what they are doing is just taking redistribu
tion into their own hands.
The Welfare State
In another way, the policy elites bear an even more direct respon
sibility for the problems of the urban poor, for they created the
welfare state and its corollaries that trap people in ghettos. The
sound and fury over family values, single motherhood, and Mur
phy Brown obscured the real point: We don't have to condemn
192
The Inner City
the single mother to acknowledge that of course it is better to be
reared in a two-parent family. Children living in fatherless homes
are five times more likely to be poor. And beyond the problem
of poverty, it is increasingly clear that mothers alone have great
difficulty controlling-civilizing-teenage boys. That problem is
worse for black single mothers than for white, because white single
mothers tend to live in communities dominated by two-parent
families. But in some inner-city black neighborhoods, 80 percent
of the families are female headed. There are hardly any role models
from whom young boys can learn how to be responsible men.
There will always be some unwed mothers and some divorced
or widowed mothers. But a society that offers pregnant teenagers
enough money to get an apartment of their own should not be
surprised that teenage pregnancy and motherhood are on the rise.
When people pay for the consequences of their actions, they still
make mistakes-but they make fewer than when government
absolves them of responsibility.
The stark truth is that as long as the welfare state makes it possible
for young women to have children without a husband and to sur
vive without a job, the inner city will continue to be marked by
poverty, crime, and despair. What, then, can we do about Ameri
ca's most difficult problem? Many solutions have been offered,
most of them promising more of the same or niggling reforms.
After the Los Angeles riots, many people blamed "the Reagan
Bush cutbacks" and demanded that we spend more money on the
cities and the poor. Most of those people had a clear self-interest:
they were social-services providers, mayors, urban congressmen.
But the Old Paradigm flag was proudly waved even by such a
distinguished scholar as Anthony Downs of the Brookings Institu
tion: "The conclusion that social programs don't work is dead
wrong. Throwing money at poverty works beautifully. The problem
is, we haven't thrown enough money at it, and not in the most
effective ways. "2
One has to wonder, though, with anti-poverty spending five
times higher in real terms than in 196, just how much more money
the Old Paradigmers think might work. Many of them are throwing
in the towel. One prominent liberal Democratic social-policy analyst
2
Los Angeles Times, June 6, 192.
193
MARKET LIBERALISM
told me recently that he thought well-designed and well-funded
government programs could improve the urban-poverty situation
by maybe 5 percent. If that's the argument for doing more, it seems
time to do something different.
The latest "something different" is requiring that welfare recipi
ents either work or enter job training. Such plans are now being
tried in several states, by both Democratic and Republican gover
nors, but
a review of workfare programs with strong job-search com
ponents conducted by the Manpower Demonstration
Research Corporation found employment gains among wel
fare participants generally no better than 10 percent. Even
the administrators of Massachusetts' celebrated ET-Choices
program could claim a net drop in the welfare rolls of only
4. 5 percent from 1983 to 1986, a time of vigorous statewide
economic growth. Similarly in New York, another state with
extensive and highly touted job training and employment
programs, the welfare case load has fallen by a mere 4. 5
percent over the same period. 3
Aside from the general problem of ineffciency in government
bureaucracies, we might note the incentive problems in such an
effort: What happens to social workers if they get all their clients
off welfare? How many people will work hard to eliminate their
own jobs? Yet another problem is that we flinch at enforcing such
rules: If a welfare recipient doesn't find-or doesn't take-a job,
do we cut her off, leaving her children to go hungry next week?
If we are not ready to summon the will to do that, then workfare
is doomed to fail. Widespread support for workfare and similar
programs probably reflects a somewhat surly and paternalistic atti
tude on the part of taxpayers-"If they're going to take our money,
let's at least make 'er work"-rather than a concern for the well
being of those trapped in the welfare net or a real conviction that
workfare would actually move people into the productive economy.
In any case, now that dissatisfaction with the existing welfare
system is widespread, and faith in "enough money" is dying, we
are probably doomed to a decade of piecemeal reform, with another
3
Kevin R. Hopkins, "A New Deal for America's Poor, " Polic Reie, Summer
1988, p. 70.
194
The Inner City
generation of children coming of age in a system much like today' s.
Charles Murray, a long-time evaluator of social programs who has
become the most trenchant critic of welfare, was asked a few years
ago to point out one or two programs that had actually worked.
His reply was, "1 cannot think of a single large program, state or
federal, that I consider to be a meaningful success.
,,
4
A bold president or governor would reject the Gorbachev-like
attempt to make our homegrown socialism work and move forth
with to the Yeltsin era: recognize that socialism doesn' t work and
be done with it. Such an executive would recognize that no one
has come up with a compelling program better than the "thought
experiment" Charles Murray proposed at the end of Losing Ground.
We have available to us a program that would convert a
large proportion of the younger generation of hard core
unemployed into steady workers making a living wage.
The same program would drastically reduce births to single
teenage girls. It would reverse the trend line in the breakup
of poor families. It would measurably increase the upward
socioeconomic mobility of poor families. These improve
ments would affect some millions of persons.
All these are results that have eluded the efforts of the
social programs installed since 1965, yet, from everything
we know, there is no real question about whether they
would occur under the program I propose . . . .
The proposed program, our final and most ambitious
thought experiment, consists of scrapping the entire federal
welfare and income-support structure for working-aged per
sons, including [Aid to Families with Dependent Children],
Medicaid, Food Stamps, Unemployment Insurance, Work
er's Compensation, subsidized housing, disability insur
ance, and the rest. It would leave the working-aged person
with no recourse whatsoever except the job market, family
members, friends, and public or private locally funded ser
vices. It is the Alexandrian solution: cut the knot, for there
is no way to untie it. . . .
The prospective advantages are real and extremely plausi
ble. In fact, if a government program of the traditional sort
(one that would "do" something rather than simply get out
of the way) could as plausibly promise these advantages, its
4
Charles Murray, "Aw, Never Mind," Washington Monthly, June 1988, p. 40.
195
MARKET LIBERALISM
passage would be a foregone conclusion. Congress, yearn
ing for programs that are not retreads of failures, would be
prepared to spend billions. 5

Murray's program is more than bold. It is in many ways harsh.

Real people would suffer from the abolition of welfare. Perhaps
those who would be hurt the most are those-like divorced or
widowed women-who use welfare the way it was intended, as
a temporary support while they work out a new way of supporting
themselves. Without welfare, they would have to find other
.
arrangements. But the very fact that they remain on AFDC only
temporarily means that they are capable of fnding jobs, new mar
riages, or other means of support.
Those who stay on welfare for years at a time would have a more
difficult adjustment, but there are high costs associated with the
attempt to absolve people of the consequences of their actions.
When we offer pregnant teenagers their choice of a subsidized
abortion or a subsidized apartment, we will get more pregnant
teenagers. And the long-term consequences of that-for the teenag
ers, for their fatherless children, and for the rest of us-have
become appalling. If we can change the incentive structure in the
inner city, we have some hope of giving people there a decent
living. Clearly, the welfare state will never do so.
Education: The Blocked Way Out of Poverty
As long as the welfare state exists, the inner city will remain a
morass of bad incentives, fatherless families, and broken
lives. But the welfare state is not solely responsible for that condi
tion. A second contributor is the public school system. The statistics
on American education as a whole are bleak enough: Test scores
are significantly lower than they were 30 years ago, even while
real expenditures per pupil have tripled. The average Japanese
student outscores the top 5 percent of American students on math
tests.6 Inner-city schools are far worse than average. They have a
dropout rate of around 50 percent. But poor education may take a
SCharies Murray, Losing Ground: American Social Policy, IJ0-IJb0 (New York:
Basic Books, 198), pp. 227-29.
ee David Boaz, ed. , Liberating Schools: Education in the Inner City (Washington:
Cato Institute, 1991), esp. pp. 2-4.
196
The Inner City
back seat to violence as a problem in inner-city schools. The Evening
Sun reveals that 20 or more students were arrested in 23 Baltimore
schools during the spring 1992 semester. Washington is considering
installing metal detectors in high schools. New York City has
announced a $28 million program to put weapons scanners and
police officers in the schools, reflecting the fact that in or near
New York City's public schools during the 1991-92 school year, 16
students were shot and 6 were killed; 5 teachers were shot and 1
was killed. It's no surprise that 30 percent of the public school
teachers in Los Angeles send their own children to private schools,
as do 46 percent of teachers in Chicago and more than 50 percent
in Milwaukee. 7
The public schools are monopoly bureaucratic institutions, politi
cally controlled in districts so large as to be virtually immune from
political pressure, certainly pressure from uneducated and unorga
nized parents. Inner-city parents have no choice about where to
send their children and little hope of their getting a decent education
in the schools to which they are assigned. Thus, it's no surprise
that half of inner-city students drop out before high school gradua
tion and that many of those who stay for 12 years graduate unedu
cated and unprepared to enter the mainstream economy. Wisconsin
State Rep. Polly Williams, author of Milwaukee's school voucher
program, declares that the Milwaukee public schools have a 90
percent failure rate-60 percent of the kids drop out, and only 10
percent of the ninth graders eventually graduate able to read. In
today's complex economy, students who don't get a good basic
education are going to be left behind after they leave school. Once
again, the inner-city poor are the victims of a system designed by
upper-middle-class elites.
In every sector of the economy, competition produces better
results than bureaucracy and monopoly. (Not just the economy,
in fact: liberalism involves competition in political and intellectual
life as well as economic life. ) That's why the public schools don't
work very well. They offer about as much scope for flexibility,
innovation, consumer responsiveness, and experimentation as did
Soviet factories. Private schools work better, because they have to
provide a service that parents will pay for and also because they
%id. , QQ. 8-9.
197
MARKET LIBERALISM
can tailor their programs to the needs of different students and
parents. Unfortunately, many families can't afford private schools.
Poor parents need to be given the same opportunity to choose
decent schools that wealthier parents have. Each state should
implement an education scholarship plan to give students a choice
between public and private schools. Each child should receive a
scholarship, worth, say, 50 percent of the amount the state or city
spends per child, that could be taken to any public or private school
in the state. Schools would then be reimbursed by the state for the
total amount of scholarship vouchers they collected from students.
An educational choice plan would bring competition to our
schools. Schools that couldn't attract customers would go out of
business. Those that served children and parents best would
expand and be copied by other schools. We recognize the benefits
of free enterprise and competition in other markets; we should
apply those lessons to education, our last and greatest monopoly.
Educational choice would do wonders for education in every
neighborhood. But its greatest effect would be in the inner city,
where the public schools are worst and from which parents are
unable to escape. Parents generally know that inner-city schools
are atrocious; they just lack the means to escape them, either by
moving to more expensive neighborhoods or by paying private
school tuition. If every inner-city parent had a voucher worth, say,
$3,000 per child
,
we would see a flourishing variety of schools
spring up in the inner city-Catholic, fundamentalist, Afrocentrist,
traditional, even for-profit schools like those promised by Chris
Whittle's Edison Project. Children might be born into poverty, but
they would have a better chance at getting a good education, which
has always been the ticket out of poverty.
Choice would have one more benefit for the inner city that is
not widely noted. Today, middle-class families move to suburban
districts because the schools are better, even though they might
prefer to stay in the city because of its diversity, its nightlife, or its
convenience to work. By separating the choice of where to live from
the choice of where their children will attend school, an educational
scholarship plan might bring some middle-class families of all races
back to the city.8
8, am indebted to William Niskanen for this point.
198
The Inner City
War and Peace in the Inner City
The War on Drugs is another policy implemented by elites that
has devastating effects on the inner city. First, of course, one can
hardly ignore the fact that though drug users are overwhelmingly
white, almost half the people arrested for drug violations are black.
While many blacks call for a stronger police effort against drugs in
their neighborhoods, others understandably see the disproportion
ate arrest figures as a sign of a white conspiracy against the black
community. Second, the War on Drugs has brought an unprece
dented level of crime to inner cities. By now it should be clear:
Drugs don't cause crime, drug laws cause crime. Drug laws drive
prices and profits in the drug trade to astronomical levels and force
drug sales into the black market. Like alcohol prohibition in the
1920s, drug prohibition in the 1990s means not that drugs are
unavailable but that they are available only from criminals. Half
the crime in major cities is committed by addicts trying to pay for
a habit that would be easily affordable if it were legal. The more
visible and frightening crimes-the record murder rates in cities
from New York to Richmond-result from the fact that black-mar
ket buyers, sellers, and competitors have no way to settle disputes
peacefully. That is why young black men in Watts or the South
Side of Chicago are more likely to be killed than were American
soldiers in Vietnam. The violent crime arrest rate for juveniles has
tripled since 1965; it's five times as high for black juveniles as for
whites and 19 times as high as for "other races.
,,
9 Much of the
violent crime among teenagers is a result of the black market in
drugs.
Thanks in large measure to the drug laws, people in the inner
city feel under assault from criminals, or drug enforcers, or both.
But beyond those effects, drug prohibition has created a world
turned upside down in the inner city, a world in which criminals
are role models, mothers ask their teenage sons for the rent money,
and young men see three alternatives open to them: welfare,
"chump change" at a low-skilled job, or big money dealing drugs.
Drug laws make a mockery of the work ethic, undermine the family,
9pederal Bureau of Investigation study reported in "The Young and the Violent,"
Wall Street Journal, September 23, 192.
199
MARKET LIBERALISM
and destroy the natural order of the community. In so doing they
also destroy the possibility of legitimate economic development.
Thus, the third crucial reform for the inner-city poor is to end
the War on Drugs-to make the use and sale of drugs by adults
legal. The level of crime created by drug prohibition should be
intolerable to civilized people, and it would be if that crime came
to the neighborhoods of the white elite. In Washington, 482 people
were murdered in 1991, the fifth straight annual record. Only a
handful of those people were white. One wonders whether, had
it been 100 white people murdered, the public policy status quo
would have prevailed.
Besides eliminating the crime associated with the black-market
drug trade, legalization would free 30, 000 state and local law
enforcement offcials to work on violent crime. A recent study of
the drug war in Illinois found that increasing the focus on drug
crimes has had the effect of diverting resources from other crime
prevention efforts. lo
The federal government should repeal its drug prohibitions and
leave it to the states to set their own drug policies, as was done
with alcohol policy after the repeal of Prohibition. Some states
would doubtless maintain prohibition, but others would quickly
recognize the benefits of legalization. Drug legalization would not
solve all of America's drug problems, but it would dramatically
bring down the crime rate, make drug use safer, relieve our clogged
courts and prisons, and make honest work more attractive to tal
ented and ambitious inner-city youth. It would allow churches,
families, and community organizations to treat drug abuse as an
ethical and medical problem rather than asking the police to try to
enforce futile laws.
Conclusion
This is the world white elites have given inner-city blacks: a
welfare plantation, schools that fall somewhere between baby sit
ting and prison, and a community under siege from violence.
Rapper Sister Souljah' s interview with the Washington Post
achieved notoriety for its racist elements, but it also included some
insights such as this one:
IOBruce Benson and David Rasmussen, "Illinois' War on Drugs: Some Unintended
Consequences," Heartland Institute Policy Study no. 48, Apr 21, 192.
200
The Inner City
Usually this system is successful in crushing the spirit, the
mind and the hearts of young people. Because I've been
able to grow up in the welfare system, and go through the
public housing system, and go through all these govern
ment programs, and come out still in control of my own
mind and thoughts, it's unusuaL! !
Those who escape that crushing system deserve our admiration;
those who remain trapped deserve a better chance.
The three reforms suggested here are by no means the only policy
changes that would help the urban poor. Other beneficial reforms
would include repeal of minimum-wage and licensing laws, which
prevent low-skilled people from getting jobs; repeal of rent-control
and zoning laws that destroy housing and increase homelessness;
tax reduction for businesses and self-employed people in the inner
city to encourage business formation; and reduced regulation.
Cities don't need Marshall plans and central planners; they need
to give freedom, voluntarism, and markets a chance to work.
Today, despite civil rights laws, affirmative action, and the clear
evidence of black economic progress, racial relations in America
seem more acrimonious than ever. College students scrawl racial
epithets on black and Asian students' doors, black entertainers
find a wide audience for racist and anti-Semitic lyrics, resentments
fester-even though polls indicate that blacks and whites earnestly
want to get along. Both black and white Americans find that when
they talk to each other, they feel like ambassadors from their race,
carefully measuring their words to maintain the proper diplomatic
balance.
The weak economy is partly responsible for the tension; people
look for scapegoats in bad times. But the economy can't explain
the whole picture. I suggest that the welfare state and affirmative
action-poliCies adopted often with the best of intentions-have
had sweeping unintended consequences. The welfare state and the
War on Drugs have combined to create a horrifying amount of
violence in the inner city, leading ghetto residents to suspect a
conspiracy to destroy them, and middle-class whites to fear black
crime. The coercive, government-mandated form of affirmative
IlDavid Mills, "Sister Souljah's Rebellion Rap:' Washington Post, May 13, 192,
p. b.
201
MARKET LIBERLISM
action (along with such corollaries as race-norming and contract
set-asides) reflects the worst aspects of welfare liberalism: white
guilt combined with an unspoken belief that blacks can't make it
in a competitive society without such help and a preference for
group identification over ability. Affirmative action has done little or
nothing for poor and uneducated blacks while causing resentment
among white males, who fear that they are losing college and job
opportunities that they deserve. Note that, as Thomas Sowell points
out, we are not seeing a "return" to racism on college campuses;
we didn't have racial slurs scrawled on college campuses in the
1950s. Maybe what white students resent is the appearance that
minority students aren't being held to the same standards that they
are. (Political correctness is also probably responsible for some of
the racist outbursts on campus; students today know that they
can't shock the dean by showing a pornographic film, but they can
throw the whole campus into turmoil by saying something racist
or sexist. )
Another problem is the continuing growth of government. As
government controls more of society, who controls government
becomes more important. If the American government takes half
of our income, runs our schools, regulates our businesses, sets
quotas for jobs and college admissions, subsidizes art and literature,
and interferes in our personal lives, then it becomes vitally impor
tant to make sure that "we" control the government. That political
struggle plays a role in creating cultural wars in America and real
wars in Ireland, South Africa, Yugoslavia, and other multiethnic
states with centralized governments. We can reduce racial tensions
by removing more aspects of life from the political process, letting
people work together-or apart-peacefully in the market process.
One response to crime, poverty, and racial tension is to harden
our positions. Sister Souljah urges that we have "a week to kill
white people," while Pat Buchanan calls for "taking our country
back, block by block. " Even more moderate people despair of get
ting along. Poor blacks become convinced that the system is stacked
against them. Charles Murray warned several years ago that the
continuing problems of the underclass would lead white liberals
to throw up their hands in despair and support a policy of "custodial
democracy" -maintaining the welfare-state programs but confining
202
_ The Inner City
the underclass to a carefully circumscribed geographic area, like
an Indian reservation. 12
Instead, we must renew our effort to build a society based on
the virtues of choice, self-respect, and responsibility. As Murray
has pointed out in two provocative books, when we try to enhance
the self-esteem of the poor by assuring them that they are not
responsible for their condition, we deny them the self-respect that
can only come from achievement. Distinguishing self-esteem from
self-respect, Murray puts it this way: "The threshold condition for
self-respect is accepting responsibility for one's own life, for which
the inescapable behavioral manifestation is earning one's own way
in the world.
,,
13 We need to give the poor as much opportunity for
choice-in schools, housing, neighborhoods, and so on-as we
can, and then grant them the dignity of holding them responsible
for the consequences of their actions, as we (still usually) hold
responsible those we consider our peers. A healthy, vibrant culture
in the cities has been ruptured by social engineers and patronizing
politicians who have destroyed jobs, wrecked schools, and shifted
community functions to City Hall or even Washington.
There is a better answer, one that we will eventually arrive at.
We can only hope it will be sooner rather than later. That answer
is to recognize the failure of the welfare state, and to extend political
and economic freedom to the inner city.
12Charles Murray, "The Coming of Custodial Democracy," Commentary, Septem
ber 1988.
13Charles Murray, In Pursuit: Of Happiness and Good Government (New York: Simon
& Schuster, 1988), p. 122.
203
1Z. Privatizing Essential Services
Robert W. Poole, Jr.
One of the most widely used tools for reordering government
priorities is privatization. First used in the United States by Peter
F. Drucker in 1969,1 the term refers to a number of different tech
niques for shifting functions from government to the private sector.
The four major techniques of privatization are as follows:
Divestiture: government sells, leases, or gives away an asset or
enterprise to private parties who are thenceforth responsible for
its operations.
Long-term franchise: instead of developing a new infrastructure
project itself, government issues a long-term (25- to 50-year)
franchise to private enterprise to design, finance, build, and oper
ate the facility.
Contracting out: instead of delivering services using government
employees, government obtains service providers, via competi
tive bidding, for relatively short-term (one- to five-year) contracts.
Vouchers: government issues a class of service users certifi
cates that they can spend on the provider of their choice; the
government reimburses the provider for the amount of the
voucher.
The federal government has a long-standing policy (OMB Circu
lar A-76) that supposedly mandates contracting out services when
ever it can be shown that doing so is less costly than in-house
provision. To get the best value for the taxpayers' dollars, that
policy should be rigorously enforced. And vouchers can stimulate
competition among the providers and empower the users of many
social and educational services, discussed in other chapters.
This chapter will focus on the first two forms of privatization:
divestiture and franchises. The federal government is a major
'
Peter F. Drucker, The Age of Discontinuity (New York: Harper & Row, 1968).
205
MARKET LIBERALISM
funder or provider, or both, of infrastructure, and it is the owner
and operator of many large-scale business operations, most of
which are run very poorly: investment decisions are made for pork
barrel reasons, rather than return-on-investment criteria; services
are priced in irrational ways that promote waste and misuse; and
government fails to be a good steward of its valuable properties,
be they forestlands or the air traffic control system. In short, govern
ment is bad at running businesses.
The Worldwide Privatization Revolution
The past decade has seen an unprecedented rethinking and
downsizing of government around the world. By the end of 1991,
some $260 billion in state-owned enterprises had been sold to pri
vate investors, and some $100 billion in franchised infrastructure
projects were under way worldwide. 2
This trend knows no geographical or ideological boundaries. It
has been pioneered in advanced industrial countries (Britain, Japan)
and the rapidly growing Asian nations (South Korea, Hong Kong,
Malaysia). It is revitalizing the economies of developing countries
in Latin America (Argentina, Mexico) and figures strongly in the
plans of much poorer countries (Ghana, Pakistan, Sri Lanka) . And
privatization is the cornerstone of the historic transitions under
way in the former communist countries of the ex-Soviet Union and
Eastern Europe.
Although many associate privatization with conservative leaders
such as Britain' s Margaret Thatcher, privatization has been
embraced enthusiastically by leaders of many ideologies, including
Spain's Socialist Felipe Gonzalez, New Zealand's Laborite Roger
Douglas, and Argentina's Peronist Carlos Saul Menem.
Governments divest state-owned assets and enterprises for sev
eral reasons: to improve the management and productivity of the
enterprise by freeing it from state constraints, to give the firm access
to private capital markets, to broaden share-ownership among the
populace. But the most common underlying reason is financial.
Selling a state-owned enterprise typically has three major financial
impacts on government: (1) its sale price is a one-time windfall, (2)
2Lynn Scarlett and David Haarmeyer, eds. , Privatization 1992 (Los Angeles: Rea
son Foundation, 1992).
206
Privatizing Essential Services
it ends a budgetary drain in the form of subsidies, and (3) it puts
the enterprise on the tax rolls as an ongoing source of corporate
and property tax revenues.
Likewise, governments use the private sector to finance, develop,
and operate new infrastructure for both performance and financial
reasons. 3 Forcing a highway, airport, or water system to meet a
market test helps to sort out poor projects from sound ones. The
private sector's use of market pricing helps to get optimum use of
the project's capacity; market pricing gives users tangible incentives
to conserve on their use of the resource, especially at peak periods.
And providing the project with a built-in source of revenue ensures
proper ongoing maintenance. Financially strapped governments in
dozens of countries are finding that private capital can supplement
limited government resources in meeting pressing needs for
improved infrastructure.
The United States today is strangely out of step with worldwide
trends. Although the federal government-like most of the govern
ments that have embarked on large-scale privatization-runs huge
annual deficits and builds up enormous debt, it has only privatized
a single enterprise (Conrail in 1987. A handful of state and local
governments have experimented with infrastructure franchises, but
such projects have been hindered by federal grant regulations and
the federal tax code.
The new administration can embark on a much bolder course,
crafting a privatization agenda that builds on a decade of experience
around the globe. Doing so will shrink the budget deficit and
improve productivity by stimulating new investment in vitally
needed infrastructure improvements.
Selling Federal Assets and Enterprises
With its endless stream of budget deficits and soaring national
debt, the United States is long overdue for a sustained, long-term
program of downsizing government. Our major industrial competi
torS-including Britain, Germany, Italy, Japan-are all engaged in
large-scale national programs of privatizing state-owned assets and
enterprises. Although federal assets and enterprises account for a
3Robert W. Poole, Jr. , "Incentives for Mobility: Using Market Mechanisms to
Rebuild America's Transportation Infrastructure," Reason Foundation Issue Paper
no. 1 16, August 1989.
207
MARKET LIBERALISM
smaller share of GDP in this country than in most countries in
Europe, a privatization program would make a significant contribu
tion to a long-term deficit-reduction effort that included basic
reform of entitlement programs.
The groundwork for such a privatization program was laid in
the late 1980s. The President's Commission on Privatization out
lined and j ustified an initial privatization agenda. 4 And that agenda
was followed by a more sweeping set of recommendations from
the ad hoc Privatization Task Force representing a number of public
policy think tanks. 5
Those efforts identified over $300 billion i n salable federal assets
and enterprises. The Privatization Task Force estimated that selling
those entities and using the proceeds to pay down federal debt
would produce annual interest savings of $29 billion, eliminate over
$6 billion per year in operating subsidies, and generate $1 . 5 billion
per year in new federal corporate tax revenue. 6 The following para
graphs discuss some of the major assets that could be sold.
Air Traffc Control System
The air traffic control system is owned and operated by the Fed
eral Aviation Administration, the agency responsible for regulating
airlines and airports for safety and for licensing pilots, mechanics,
and air traffic controllers. The ATC system is a vital high-tech
organization that must operate reliably 24 hours a day, 365 days a
year-as must the telephone system and oil and gas pipelines
(virtually all of which are privately owned and operated).
The aviation community is painfully aware that the ATC system
is failing to keep pace with the needs of commercial aviation. Airline
traffic has increased by two-thirds since deregulation, but the con
troller workforce is one-third smaller in relation to traffic levels
than before the 1981 controllers' strike. Because of civil service
constraints, the FAA cannot attract and keep enough experienced
controllers in the busiest, most stressful locations. ATC computers,
4
David F. Linowes, Privatization: Toward More Efective Government (Washington:
President's Commission on Privatization, March 1988).
SRobert W. Poole, Jr. , ed. , Federal Privatization: Toward Resolving the Defcit Crisis,
Report of the Privatiztion Task Force (Santa Monica: Reason Foundation, June 1988).
6Philip E. Fixler, Jr. , Robert W. Poole, Jr. , and Lynn Scarlett, Privatiztion I JbJ
(Santa Monica: Reason Foundation, 1989).
208
Privatizing Essential Services
radars, and other equipment are often outdated and unreliable;
indeed, it is literally the case that the FAA is the country's largest
user of vacuum tubes!
One result of those problems is flight delays. Because of the ATC
system's limited capacity to handle flights safely, it uses a process
called "flow control" to hold aircraft on the ground. A recent study
by the Aviation Consumer Action Project found that half of all
airline delays were due to ATC problems (in contrast to the FAA's
claim that weather causes most of the delays) . 7 The Department of
Transportation has estimated that delays cost airlines and travelers
some $5 billion per year.
Another problem is decreased safety. Although the trend lines
for aviation accidents continue downward, ATC deficiencies have
contributed to a number of recent fatal crashes, including ground
collisions at Detroit Metro and Los Angeles International airports.
Both of those accidents resulted from the lack of a functioning
ground radar system.
The fundamental problem is that the ATC organization is crippled
by being a government agency. Civil service rules and federal pro
curement regulations are incompatible with efficient management
of a demanding, high-tech service business. Federal budget con
straints and congressional oversight also hamstring the ATC sys
tem. Ard operating the ATC system gives the FAA a built-in confict
of interest. Like the former Atomic Energy Commission (which was
charged with both promoting nuclear power and regulating its
safety), the FAA is supposed to promote the economic health of
aviation and regulate its safety. Spinning off ATC would put that
system at arms length from FAA safety regulators, as are the air
ports, aircraft producers, and airlines.
Spinning off ATC has been recommended by several think tanks,
the Air Transport Association, and the Aviation Consumer Action
Project. Several other countries have done or are in the process of
doing just that. Five years ago New Zealand corporatized its ATC
system by setting up a 100 percent user-funded Airways Corpora
tion of New Zealand. The company is profitable and has completed
a major upgrade of the ATC system. It is on the list of state-owned
7James Ott, "Consumers Urge U. 5. to End FAA Control of ATC Services," Aviation
Week & Space Technolog, July 20, 1992.
209
MARKET LIBERALISM
firms to be privatized. In 1988 the Swiss congress spun off its ATC
system as SwissControl . Though the Swiss government holds 71
percent of the shares, the remaining shares are owned by airlines,
airports, and user groups.
Other countries are moving in the same direction. The German
parliament enacted constitutional amendments that will merge
civilian and military ATC and spin it off as a user-funded company
in 1993. The South African government took similar action in 1992,
to take effect in mid-1993. The Air Transport Association of Canada
has proposed that the Canadian government do likewise, given
the successful model of Airways Corporation of New Zealand. And
the Association of European Airlines is promoting the unification
of European ATC as a user-funded corporation.
Privatizing our ATC system would free it from bureaucratic con-
.
straints, provide access to private capital, and accelerate its badly
needed modernization. 8
Amtrak
The National Railroad Passenger Corporation (Amtrak) was cre
ated in 1971 to take over passenger service from the major railroads.
Amtrak was intended to become a profitable corporation, and a
minority of its shares are privately owned. But for 20 years Amtrak
has operated at a loss. Its subsidy peaked at $881 million in 1981
and has declined steadily since then. In 1981 fares covered only 48
percent of operating costs; in 1992 they are expected to cover 84
percent.
Although Amtrak gets half its passengers from the Northeast
Corridor (NEC), its costs there are extremely high, in part because
there alone it owns and must maintain the track. Amtrak is also
hobbled by numerous federal laws and regulations, some of which
were relaxed for Conrail to facilitate its successful privatization in
1987.
Overseas, privatization of passenger railroads began several
years ago with the reorganization of Japan National Railways. In
1987 JNR, which had run up debts of $264 billion, was split into
six passenger rail companies, a freight railroad, and several ancillary
firms (including a property disposal firm to sell real estate for debt
BRobert W. Poole, Jr. , "Building a Safer and More Effective Air Traffic Control
System," Reason Foundation Policy Study no. 126, February 1991.
210
Privatizing Essential Services
reduction). By 1991 all six passenger railroads were in the black,
and several may be privatized in 1992 or 1993.
Elsewhere, both Argentina and New Zealand plan to privatize
their national railways by 1993. Sweden and Britain are taking a
different approach, setting up a track corporation to manage the
infrastructure and opening access to competing rail service firms.
Sweden's first private rail firm, BK-Train, has cut fares in half and
increased ridership by 40 percent.
Amtrak's improved performance during the past decade has led
some rail advocates to support its privatization. For example,
Andrew Selden imd others have suggested that reform of NEC
operations, slimmed-down management, development of traffic
hubs, and regulatory reform would permit Amtrak to become
profitable. 9 In particular, Amtrak employees should be shifted from
Ra
i
lroad Retirement to Social Security and from the Federal
Employee Liability Act to ordinary workers' compensation.
Rather than grant Amtrak new, permanent subsidies (it is now
requesting entitlement to a portion of federal gasoline taxes), Con
gress should give it, say, a four-year restructuring period, capped
federal assistance, and immediate regulatory relief, after which all
subsidies would be terminated and the government's shares would
be sold.
U. S. Postal Service
As a business, the U. s. Postal Service is inefficient and user
unfriendly. In those areas where competition is legal, it has steadily
lost market share: it retains only 5 percent of the parcel business
and 11 percent of overnight express delivery. Despite investing
billions in automation, it remains extremely labor intensive, hob
bled with cost-increasing work rules. (For example, while competi
tor United Parcel Service uses 40 percent part-timers and Federal
Express 30 percent, the Postal Service has fewer than 20 percent
part-timers. ) Postal wages are about 25 percent higher than market
levels.
Competition would force the Postal Service to streamline, but
under its present bureaucratic style of management (and oversight
9 Andrew C. Selden, Statement presented to the Transportation Subcommittee
on Amtrak Privatization of the House Energy and Commerce Committee, April 9,
1987.
211
MARKET LIBERALISM
by Congress), the Postal Service would be at a disadvantage. Hence,
privatization should by accompanied by deregulation, freeing the
Postal Service to enter any related business (e. g. , electronic mail)
and to tap the private capital markets. Douglas Adie has proposed
breaking up the huge Postal Service into several regional companies
that would be sold via public stock offerings. 1O Blocks of shares
would be set aside for postal employees, giving them a stake in
the success of the new firms.
Several other countries are moving toward privatization of postal
services. New Zealand has deregulated and corporatized its postal
service and Australia is studying privatization. Malaysia's parlia
ment has passed legislation to privatize Pos Malaysia; Singapore
plans to do likewise. Denmark has decided to corporatize its postal
service and sell 25 percent of the shares to investors. Sweden's
new government includes postal service among its privatization
targets. Canada plans to sell shares in Canada Post to its postal
workers. Most recently, the British government announced a major
review of the future of the British Post Office, which will include
consideration of a buyout by management and workers.
A state-owned postal monopoly is becoming an anachronism.
Adie's analysis indicates that the government could net over $11
billion by selling the Postal Service. A competitive mail delivery
industry would be a boon to businesses and individuals alike.
Electric Utilities
The federal government is the largest single producer and mar
keter of electricity in the United States. The Tennessee Valley
Authority is the nation's largest utility firm, and five federal power
marketing administrations (PMAs) supply 6 percent of all U. S.
wholesale electric power.
All over the world, governments are divesting themselves of
such enterprises. Britain broke up its massive Central Electricity
Generating Board into two generating companies and 12 transmis
sion firms, valued at over $19 billion, all of which were sold to
investors in 1990 and 1991. Argentina is selling SEGBA the state
electric utility in Buenos Aires. In Canada the provincial utility
Nova Scotia Power has been sold off this year. Other countries
IODouglas K. Adie, Monopoly Mail: Privatizing the U. S. Postal Service (New Bruns
wick, N. J. : Transaction Books, 1989).
212
Privatizing Essential Services
selling electric utilities include Austria, Chile, Finland, Nigeria, the
Philippines, and South Korea.
Douglas Houston has proposed that the TV A be split into several
generating companies and a transmission company, which would
be sold separately for about $12 billion. ] ] The five PMAs may be
worth as much as $14 billion; their sale would also eliminate nearly
$2 billion a year in federal subsidy. Putting all of those enterprises
on the market, with generation separated from transmission, would
foster the emerging trend toward a more competitive national elec
tricity market. The elimination of federal subsidies and market
pricing of electricity, reflecting the true cost of the resources used
in producing the energy, would motivate conservation.
The production and distribution of electricity are being privatized
around the world. We are far behind in applying to our remaining
government-owned utilities the lessons the rest of the world has
learned.
Electromagnetic Frequencies
The past decade has seen the development of exciting new com
munications technologies, including direct broadcast satellites, cel
lular mobile phones, and personal communications networks. A
major factor constraining the growth of such technologies is the
misallocation of the frequency spectrum. Under the historic doc
trine that treats the spectrum as a commons, a government
agency-the Federal Communications Commission-is charged
with making decisions to allocate portions of the electromagnetic
frequency spectrum to competing uses.
Nearly all other scarce resources are allocated by market forces,
and market forces are equally applicable to the frequency spectrum.
What's needed is to define and auction property rights to specific
frequency bands and to permit market exchange among the various
owners.
In 1989 New Zealand became the first country to implement that
approach. 12 Jt switched to auctions as the method for allocating the
spectrum, and it defined long-term, tradable property rights for AM
I
I
Oouglas Houston, "Privatization of the Tennessee Valley Authority," Reason
Foundation Issue Paper no. 106, October 1988.
12Milton Mueller, "Reform of Spect

um Management: Lessons from New

Zealand," Reason Foundation Policy Study no. 135, November 1991.
213
MARKET LIBERALISM
and FM radio, UHF television, cellular frequencies, and microwave
bands. Auctions were held for all of those segments in 1989 and
1990.
A proposal by Milton Mueller for the U. S. frequency spectrum
would create permanent property rights for AM, FM, VHF, and
UHF broadcast frequencies. Incumbent broadcasters would pay a
one-time fee to acquire their property right, after which they would
be free to buy or sell as they chose. The plan would raise an
estimated $8. 6 billion. 13 Mueller proposed that $2. 5 billion of that
sum be used as an endowment for public broadcasting, to free it
from the need for ongoing subsidy.
Privatization would permit frequencies to go to their highest and
best use, thereby responding to changing consumer needs. It would
also eliminate federal licensing and content regulation, a threat to
First Amendment freedoms.
Surlus Militar Bases
The end of the Cold War has greatly increased the potential
number of surplus military bases in this country. Only 300 of some
1, 300 such bases have been defined by the Defense Department as
"essential" to national security-and that was during the height
of the Cold War.
Much of the local opposition to base closings is unfounded. A
1986 Pentagon study of 100 base closings found that 138, 000 new
jobs were created to replace the 93,000 military-related jobs that
were lost. That's hardly surprising, since most such bases can be
readily recycled into industrial parks, schools, or airports. Most
core well equipped with an infrastructure of roads, water, sewers,
and electricity, even if their buildings are not usable.
Unfortunately, present federal law on base closings is rigged
against the taxpayers. The order of procedure stresses giveaways,
not sales: first, other federal agencies are asked if they want the
base; if they don't, then state and county governments can ask for
it, for free. Only if all else fails does the Defense Department try
to sell the property to investors.
1
3
MiJton Mueller, "Property Rights in Radio Communications: The Key to the
Reform of Telecommunications," Cato Institute Policy Analysis no. 11, June 3, 1982;
and Milton Mueller, "Privatization of the Airwaves," Reason Foundation Policy
Study no. 105, April 1988.
214
Privatizing Essential Services
That order of priority should be reversed. The first alternative
should be to put the property on the market, for sale to the highest
bidder. Many of the nonessential bases are premium properties:
the Presidio in San Francisco; Ft. Sheridan on the shore of Lake
Michigan north of Chicago; Camp Pendleton in booming Orange
County, California; Ft. DeRussy on the beach at Waikiki. Selling
200 bases valued at an average of $50 million would yield $10 billion.
That would be a handsome addition to the savings in operating
costs to be realized from downsizing the military.
Naval Petroleum Reserves
Despite having spent over a billion dollars creating the Strategic
Petroleum Reserve during the 1980s, the government still retains
ownership of two commercial oil fields. The Naval Petroleum
Reserves consist of the oil fields at Elk Hills, California, and Teapot
Dome, Wyoming.
The President's Commission on Privatization found that those
reserves no longer play a key role in Defense Department planning
for an energy emergency and recommended that they be sold.
The commission cited studies estimating the value at between $3. 6
billion and $4. 2 billion. Their finding is equally valid today.
Commodity Lands
The federal government is by far the largest landowner in the
United States. Including national forests, grazing lands, wilderness
areas, national parks, defense installations, and other categories of
property, the government owns some 2. 2 billion acres. Of that
total, 273 million acres (about 12 percent) are commercial forest and
grazing lands.
Although those lands are operated by the Forest Service and the
Bureau of Land Management as commodity-producing, ostensibly
commercial undertakings, the two federal agencies manage to lose
about $1 . 3 billion per year. The Forest Service spends a fortune
building logging roads to areas whose timber value cannot begin
to j ustify the road-building costs. And the BLM charges grazing
fees that are less than half the going rate on comparable private
land.
Economist Terry Anderson has reviewed the potential value of
those commodity lands. Assuming that the lands in the lower 48
states would bring an average of $500 per acre at auction, and
215
MARKET LIBERALISM
those in Alaska half that amount, the total proceeds would be $160
billion. 1 4
Anderson suggests several provisions to mitigate opposition.
Existing lease obligations could be written into future land con
tracts, so that purchasers would have to honor them. The govern
ment could donate parcels with low commodity value but high
amenity value to environmental land trusts before any auctions.
And user fees for recreation programs should be implemented
throughout the federal lands, so that having to pay for access
becomes routine, rather than something encountered only on pri
vately owned lands.
Land sales of that magnitude should not take place all at once,
for there would be a serious risk of swamping the market and
depressing price levels. Anderson suggests a lO-year cycle of auc
tions, with the proceeds dedicated to debt payoff. He cites a prece
dent from America's early history: between 1789 and 1840 land
sales were used to fully retire our original national debt.
Table 12. 1 provides a summary of potential federal asset sales
and their resulting budgetary impacts.
Empowerng State and Local Goverments
Like the federal government, state and municipal governments in
the United States own and operate far more commercial enterprises
than most people imagine. State and municipal socialism is alive
and well in the land of free enterprise. Yet as dozens of other
countries are realiing, government has no comparative advantage
in operating utilities and infrastructure enterprises that lend them
selves to direct user charges. Selling or leasing those enterprises
can improve their performance while helping cities and states out
of their current fiscal crises.
What do cities and states have to sell? Table 12. 2 itemizes selected
infrastructure enterprises that are considered potential candidates
for sale. The table includes only those facilities that could be fully
self-supporting from user payments, independent of government
support or contracts. Thus, it excludes public housing, jails and
prisons, public schools, and other types of infrastructure that would
lerry Anderson, "Rekindling the Privatization Fires: Political Lands Revisited,"
Reason Foundation Issue Paper no. 108, July 1989.
216

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MARKET LIBERALISM
Table 1 2. 2
SALABLE STATE AND MUNICIPAL ENTERPRISES
Enterprise T
Airports (commercial)
Electric utilities
Gas utilities
Highways and bridges
Parking structures
Ports
Turnpikes
Water systems
Wastewater facilities
Waste-to-energy plants
Total
Estimated
Number
87
2,010
800
nla
37,500
45
8
34,461
15,300
77
Estimated
Market Value
($ Billions)
29. 0
16. 7
2. 0
95. 0
6. 6
1 1 . 4
7. 4
23. 9
30. 8
4. 0
$226. 8
depend on government contracts. As can be seen, those salable
enterprises have an estimated value of $227 billion.
1D
Although most of those enterprises are traditionally public-sector
activities in the United States, the worldwide trend is toward priva
tization of all of them. Some two dozen countries (including Britain,
Canada, Denmark, Germany, and Greece) are now actively
involved in airport privatization, either selling existing airports or
franchising the private sector to produce new airports or terminals.
Some 36 governments worldwide (among them are those of Britain,
Hong Kong, Malaysia, Singapore, and Venezuela) are considering
privatizing their seaports or are already doing so. Water supply
and wastewater treatment are 70 percent privatized in France and
100 percent privatized in Britain. Municipal electric and gas utilities
and parking structures are the exception to the general U. S. practice
of investor ownership of those types of facilities; there would be a
ready market if they were put up for sale.
In fiscal year 1992 Congress and the president each made an
important start on giving state and local governments the power
I
SRobert W. Poole, Jr. , David Haarmeyer, and Lynn Scarlett, "Mining the Govern
ment Balance Sheet: What Cities and States Have to Sell," Reason Foundation Issue
Paper no. 139, April 1992.
218
Privatizing Essential Services
to privatize. Congress included far-reaching privatization provis
ions in the Intermodal Surface Transportation Efficiency Act of 1991
(ISTEA). And President George Bush issued Executive Order 12803
on Infrastructure Privatization on April 30, 1992. The new adminis
tration must see to it that full advantage is taken of those promising
initiatives.
Privatizing Highways
ISTEA reversed the federal government's historic opposition to
direct user payments for highways. Although it is still not legal to
add tolls to most Interstate highways, ISTEA does permit states to
convert all other federally aided highways, bridges, and tunnels
to toll facilities. It also allows states to sell or lease existing highways
and bridges to the private sector and grant long-term franchises to
finance, build, and operate new ones. Those changes could have
a major impact on this country's deteriorating highway and bridge
infrastructure.
The Federal Highway Administration's latest report on the condi
tion of our highway system calculated that simply to maintain
our highways' present mediocre physical condition would require
spending $13 billion more each year than we spend at present (and
to restore the level of quality of 20 years ago would take a $42
billion annual increase) . One recent analysis estimated that the
privatization provisions of ISTEA could attract some $19 billion per
year in net new private investment to rebuild and expand existing
highways and bridges and to add selected new capacity.
1
6 That
would represent a 50 percent increase in current investment levels.
Another major increase in investment could be brought about
by repealing various federal mandates on highway construction.
Repealing the Davis-Bacon Act would cut highway project costs
by up to 30 percent, the equivalent of a 30 percent increase in
available investment funds. Minority set-aside and "Buy Ameri
can" provisions add another 15 percent. Thus, removal of federal
mandates could bring about another 45 percent increase in net
investment.
16Robert W. Poole, Jr. , "Private Tollways: How States Can Leverage Federal High
way Funds," Reason Foundation Issue Paper no. 136, February 1992.
219
MARKET LIBERLISM
The Federal Highway Administration has begun a project to
encourage state transportation departments to make use of privati
zation provisions. The new administration should accelerate those
efforts, perhaps by creating demonstration projects in a number of
states. And it should encourage Congress to remove the remaining
ban on including Interstate highways in the privatization program.
Some of the highways most in need of upgrading are Interstate
facilities. And urban Interstates would especially benefit from the
shift to direct user payment, with higher charges at rush hours to
control traffic congestion.
A growing number of other countries are using the private sector
to fnance, build, and operate highways under long-term franchise
agreements. In Europe, Italy, France, and Spain have developed
much of their intercity superhighway network by that method over
the past 30 years. In the last few years, Britain and Greece have
launched their first privatized highway and bridge projects, and
now Hungary, Czechoslovakia, and other East European countries
are following suit. The Channel Tunnel is currently the world's
largest private infrastructure project, at some $14 billion. Private
tollways are also spreading to Latin America (Argentina, Mexico,
Venezuela) and the Pacific Rm (Australia, China, Hong Kong,
Malaysia, Thailand) .
Before passage of ISTEA, five states and Puerto Rico had enacted
legislation to permit private tollway projects. As of 1992 the first
such project (a toll bridge in San Juan) was under way, and two
toll roads (one in California and another in Virginia) had been
designed and capital for their construction was being raised.
Selling State and Local Enterprises
Executive Order 12803 on Infrastructure Privatization was
designed to do for other types of state and municipal infrastructure
assets what ISTEA did for highways and bridges: permit and
encourage the sale or lease of existing facilities and encourage the
private sector to add needed new capacity. The order directs federal
agencies that have made grants to assist with any type of infrastruc
ture (e. g. , airports, highways, housing, schools, prisons, ports,
water systems, waste disposal systems) to approve requests by
states or cities to sell or lease those facilities. It sets forth clear rules
on repayment of federal investment and on use of the proceeds by
the state or city that sells the asset.
220
Privatizing Essential Services
Although the executive order has received little publicity, a num
ber of cities and states have begun exploring the sale or lease of
infrastructure. Maryland, Michigan, and New York have state-level
commissions or task forces identifying candidates for privatization;
Dallas and Philadelphia are among the cities that are doing so. Los
Angeles is looking into privatizing or corporatizing its major airport.
The principal motivation for those efforts is financial. States and
cities are fiscally stressed, as is the federal government. But states
and cities generally have balanced-budget requirements. Privatiza
tion of infrastructure enterprises offers them a way of converting
physical assets into financial assets-what some have termed "min
ing the government balance sheet. " In addition to realizing the
capital value of the enterprises, privatization would put those valu
able properties on the tax rolls; as private enterprises, they would
pay whatever corporate and property taxes other private firms
must pay.
But as noted above, there are additional good reasons for chang
ing the ownership of those enterprises. Managers answerable to
investors are far more likely to charge market prices than are gov
ernment managers subject to political pressures. Thus, for energy
and water utilities, there will be price incentives for users to con
serve. Likewise, market pricing of waste disposal facilities will
encourage waste reduction and recycling. And market pricing of
highways and airports will encourage shifting of trips out of con
gested peak periods, thus making better use of the facilities.
Capital investment decisions, either for expansion of existing
infrastructure or for creation of new facilities, will be based on
sound return-on-investment criteria when the capital must be
raised from private sources. That will serve as a powerful restraint
on devoting scarce capital to projects that are politically attractive
but economically unwise.
Privatization will also make more capital available for badly
needed modernization of airports, highways (e. g. , nonstop elec
tronic toll collection and other "smart highway" features), and
environmental infrastructure. Freed from arbitrary governmental
budget constraints, those vital systems will get the modernization
they badly need.
Furthermore, when building new projects or rebuilding existing
ones, private firms are not bound by cumbersome, time-consuming
221
MARKET LIBERLISM
public-bidding and procurement regulations, which drive up costs
and add extensive delays. On privatized infrastructure projects,
firms today typically use a technique called Design/Build, in which
the designers and construction contractors work as a team from
the outset. That leads to a more buildable design and minimizes
costly and delay-causing modifications during the construction proc
ess. Thus, the new capacity is likely to come into service signifi
cantly sooner under privatization.
Finally, the National Commission on Public Works Improvement
called attention to the serious problem of "deferred maintenance"
in much public-sector infrastructure. There are strong pressures in
the public sector to spend limited resources on more visible projects
and needs, rather than on routine maintenance. Yet skimping on
maintenance is very costly in the long run. Under private owner
ship, deferred maintenance is reflected in reduced asset value,
which leads to strong incentives for proper maintenance. (In addi
tion, covenants in bond agreements generally require specified
levels of maintenance to protect the bondholders' investments. )
The potential for improving the nation's infrastructure by privati
zation, and simultaneously giving state and municipal finances a
strong boost, is quite large. But the extent and nature of the federal
agencies' compliance with the executive order will be critical to the
outcome. In the frst few months after issuance of the order in 1992,
the Environmental Protection Agency took a positive, pro-active
stance, holding a workshop and planning pilot projects dealing
with wastewater treatment plants. By contrast, the Federal Aviation
Administration took no action, deciding simply to wait and see if
it received requests from airport operators.
The new administration should appoint agency heads who are
committed to privatization and will work enthusiastically to imple
ment both the letter and the spirit of the executive order. In addi
tion, it should reestablish the position of "privatization czar" within
the Office of Management and Budget. The czar would serve as a
kind of ombudsman for cities and states (and the private sector)
in dealing with the agencies charged with implementing the order.
Conclusion
During the 1960s and 1970s, America's big businesses went on
an acquisition spree. The "conglomerate" craze was based on the
222
Privatizing Essential Services
idea that bigger was better, and that patching together dozens of
unrelated businesses into a corporate giant would somehow lead
to synergy and economies of scale. In fact, it generally led to costly
central offices, high overhead, and excessive layers of management.
The corporate restructuring of the 1980s and 1990s, as painful as
it can be, has been a necessary corrective to mindless growth.
Government in the 1990s resembles the conglomerates of the
business world. Over the decades, government at all levels-local,
state, and federal-has taken on function after function, program
after program, getting into numerous areas in which it has no
comparative advantage-and adding numerous layers of bu
reaucracy and costly overhead in the process. It is time for govern
ment to downsize, shedding functions that the private sector can
handle. That is the meaning of today's privatization revolution.
223
ARTN
MTERMATlOMAL FFARS
1J. Taking the Offensive in Trade Policy
Brink Lindse
In the current trade policy debate, support for free trade generally
means support for negotiated liberalization. In other words, the
United States should lower its trade barriers, but only if other
countries agree to do the same. At present, free-trade credentials are
established by favoring regional liberalization through the North
American Free Trade Agreement (NAFTA) and multilateral liberal
ization through the Uruguay round of General Agreement on Tar
iffs and Trade (GAIT) talks.
Unfortunately, pursuing free trade through negotiations is a
deeply flawed strategy. Conceptually, it relies on the same funda
mental premises that underlie protectionism. And in practice, its
accomplishments in opening markets and keeping them open have
been modest to marginal.
There is a simpler and better approach to reducing trade barriers:
unilateral free trade. Supporters of open markets should give up
on negotiations and instead call for the elimination of restrictions
on foreign goods, services, and investment here in the United
States, regardless of what other countries choose to do. That means
taking the intellectual offensive; it means challenging the whole
mercantilist world view on which protectionism is based.
Two Versions of Mercantilism
For all its intensity and even acrimony, the current dispute over
trade policy actually rests on a fundamental consensus. That con
sensus, expressed in its simplest terms, is that exports are good
and imports are bad.
Of course, one expects that sort of thinking in the protectionist
camp. Desire for a "favorable" balance of trade (i. e. , more exports
than imports) is the hallmark of mercantilism, whether in the 18th
century or at the dawn of the 21st. Modern-day mercantilists, cast
ing themselves as champions of "fair trade," rail against unfair
227
MARKET LIBERALISM
foreign obstacles to American exports and unfair advantages
enjoyed by imports. Their solution is to "level the playing field"
by closing our own markets to foreign goods.
What is curious, and regrettable, is that by and large advocates
of free trade accept, at least in practice, the same mercantilist
assumptions. Those assumptions are implicit in the whole notion
of negotiated liberalization.
In trade negotiations, countries offer to reduce import barriers
in exchange for other countries' offers of equivalent reductions.
What follows is long and complicated haggling designed to ensure
that the final bargain is equitable, that no party gains or gives up
too much. "Gains," here, means obtains improved access to foreign
markets for goods from one's country; to secure that benefit, a
country "gives up" some of its own restrictions on imports. The
operative premise, then, is that opening its markets is the price a
country must pay for improved access to markets abroad. In other
words, exports are good and imports are bad. The mercantilist
world view is quite explicit in GAIT negotiations; commitments to
reduce tariffs are referred to in the official nomenclature as "conces
sions. "
Furthermore, advocates of negotiated liberalization frequently
j ustify their position on mercantilist grounds. Supporters of NAFTA
argue that new opportunities to export to Mexico will more than
compensate for the job losses caused by increased Mexican imports.
Likewise, supporters of the Uruguay round focus on the benefits
for American exporters (e. g. , liberalization of services trade and
greater protection of intellectual property rights) and minimize the
apparent negative of greater openness to imports. President Bush
reflected that line of thinking when he claimed in his 1992 nomina
tion acceptance speech that his market-opening initiatives would
help make the United States an "export superpower. " Exports are
bragged about; imports are downplayed or even apologized for.
Indeed, the dominant disagreement in today's trade debate cen
ters on what might be called pessimistic and optimistic variants of
mercantilism. The pessimists, the protectionists, claim that imports
destroy more jobs (or good jobs) than exports create; therefore,
current liberalization initiatives should be abandoned and new
import barriers erected. The optimists, the free-traders, argue the
converse. Those opposing views, however, are simply two sides
228
Trde Polic
of the same counterfeit coin; both are based on a fundamental
misunderstanding of how international trade operates within a
national economy.
The Benefts of Import Competition
Protectionists generally admit that imports benefit the consumers
who ultimately buy them. People who buy clothes made in Hong
Kong at a low price, or a Japanese car that is of higher quality than
equivalently priced domestic models, are clearly better off than if
they had been forced to buy American. The problem, protectionists
argue, is with the longer term consequences of that immediate
benefit. They claim that imports, if unchecked, could destroy vital
American industries and erode our manufacturing base, thus
undermining productivity and ultimately our standard of living.
Their position, then, is that it is sometimes necessary to sacrifice
short-term consumer welfare for the sake of long-term economic
strength. Free trade is dismissed as economic self-indulgence.
Despite the protectionists' fears, imports are not harmful in the
long term. In fact, it is only in looking at the long term that the
full beneficial impact of imports on our standard of living can be
appreciated.
Actually, the immediate benefit of imports-lower prices or
higher quality-accrues not to individual consumers but to Ameri
can industries. Except for tourist purchases, all foreign goods are
brought into this country by businesses. Imports allow those busi
nesses to lower costs and improve efficiency, thereby becoming
more productive. That is most obvious in the case of manufacturers
who import raw materials, equipment, and components; but even
imported finished consumer goods benefit importers, distributors,
and retailers. Ultimately, the gains to the importing businesses are
passed on to American consumers in the form of better products
at lower prices.
It is thus fallacious to speak of import penetration's harming
American industry generally: yes, it takes business away from
industries that compete with imports, but at the same time it helps
industries that use and resell imports. It should be noted that many
of the imported products that arouse the fiercest calls for protection
ism-for example, steel, textiles, semiconductors, and flat com
puter screens-are used by (and benefit) American manufacturers,
thus strengthening rather than eroding our manufacturing base.
229
MARKET LIBERALISM
From the perspective of the overall national economy, the pene
tration of imported memory chips, for example, into the American
market simply means that it is cheaper for us to buy them from
abroad than to make them ourselves. Accordingly, as a society we
are richer by the amount of those savings. Over the longer term,
the manpower and resources that had been committed to making
memory chips here in the United States can be shifted to making
other things that people want. As a society, then, we not only get
the imported semiconductors for less; we also get new goods and
services produced by the people and capital that used to be tied
up in domestic memory chip production.
The role of imports in the national economy is thus analogous
to that of labor-saving machinery. From power looms to combines
to office computers, improved tools have boosted the productivity
of American labor and thus our standard of living. However, in
accomplishing their salutary effect, they also eliminate jobs. Take
computers, for exampl e. Among other things, computers have
eliminated large numbers of routine, clerical record-keeping and
number-crunching jobs. That increased efficiency brings cost sav
ings to the companies involved, and market competition passes
those savings on to consumers. We as a society are richer by the
amount of those savings. The people whose jobs were eliminated,
and the capital resources that supported those inefficient opera
tions, are ultimately redeployed in other sectors of the economy,
producing new goods and services that people want. Imported
goods can be viewed as a kind of labor-saving device: they free
people and resources to add new value to the economy. 1
Of course, the process of "creative destruction" is often messy
and disruptive. Progress has its victims: people whose jobs are
eliminated do not feel freed or liberated; they feel like their lives
have been uprooted, or even wrecked. There is genuine hardship
and suffering in losing a job, whether to a machine or a foreigner.
But if we are to continue on the course of economic growth, those
short-term and local setbacks are inevitable.
IThe analogy between imports and labor-saving machinery was made in Frederic
Bastiat, Economic Sophisms (185) (Princeton, N. J. : Van Nostrand, 196), series 1,
chap. 20.
230
Trde Policy
Protectionists see the pain and loss of boarded-up buildings in
steel towns and car towns and think they are seeing "deindustrial
ization. " A similar myopia afflicted those in the 1950s and 1960s
who fretted about the rise of computers and robots and thought
they saw an "automation crisis. " Critics of the free market confused
and continue to confuse short-term local effects (unemployment,
business closings) with general long-term trends. They fail to
understand that wealth-creation is a continuing process of getting
more value for less effort. A necessary corollary is that businesses
and jobs are eliminated as the effort they represent is no longer
necessary; that eliminated effort is then refocused on new produc
tive activities.
The beneficial effects of import penetration are only part of the
story, however; one must also look at the reaction that imports
provoke among domestic companies resisting import penetration.
Imports' dynamic effect on the intensity of competition is perhaps
the most valuable service they provide.
With the rise of trade in technologically sophisticated goods and
services, international competitive advantages have less and less
to do with the physical or traditional endowments of different
countries. There is nothing predetermined or inevitable about the
Japanese making better cars than Americans do, since the situation
was once reversed. Indeed, Japanese auto companies with "trans
plant" factories in the United States, which hire American workers
and operate under American laws and conditions, still enjoy com
petitive success, demonstrating conclusively that the secrets of car
building are not somehow rooted in the Japanese soil. Today com
petitive success is frequently a matter of intangible (and fleeting)
advantages in knowledge and organizational structure.
Under present conditions, international trade does far more than
simply push national economies into static "comparative advan
tages" of specialization. Rather, it promotes dynamic cross-border
rivalry to determine who is best at specializing in what. That is
an ongoing process in which today's winners may be tomorrow's
losers. A domestic industry may lose market share to foreign rivals
selling better pr cheaper products; subsequently, it may stop the
erosion of its market by improving quality and efficiency, and it
may even win back market share if it improves sufficiently (or
if its rivals falter) . Import competition thus improves American
231
MARKET LIBERALISM
industrial productivity (and by extension the American standard
of living) even when it does not displace American-made goods;
it does so by forcing American producers to perform better in order
to fend off foreign competition.
That effect is perhaps most visible in the case of automobiles.
Americans now drive better cars than they did 20 years ago not
just because many now drive Japanese cars; cars made by American
companies are also much better than they once were, in large part
as a response to the Japanese competitive challenge. Likewise, the
efficiency of American integrated steel producers has increased
dramatically in the face of foreign competition. American semicon
ductor manufacturers, faced with brutal Japanese competition in
high-volume memory chips, have improved their manufacturing
efficiency and concentrated resources on their own strengths in
design-intensive logic chips. Throughout the American manufac
turing sector, the presence of foreign competition has heightened
the incentives to cut costs and create new value for consumers,
and the effects of those increased incentives have been as dramatic
as they were predictable.
Open markets are thus good on their own merits
, not simply as
a means to an end. Imports are not the price we pay for greater
export opportunities; if anything, the ultimate value of exporting
is that it allows us to import more.
2
The American economy would
gain from allowing unimpeded foreign competition regardless of
the policies and conditions of other countries.
The whole notion of fair trade and a level playing field misses
the point of international trade, which is to improve our overall
long-term standard of living. Fair-traders imagine international
commerce to be a kind of game in which national teams are fielded
and winners declared. If that were the case, some sort of level
playing field would make sense; you wouldn't want the game to be
decided unfairly, whatever that means. But the purpose of market
competition, whether domestic or international, is not to pick win
ners; it is to produce better and cheaper goods and services. It is
thus irrelevant to our economic interest why given foreign products
2See, for example, Ronald Krieger, "Economics and Protectionist Premises," Cato
Journal 3, no. 3 (Winter 1983-84): 667.
232
Trade Polic
are better or cheaper than domestic products; it only matters that
they are. 3
Trade Policy and the Politically Possible
Many proponents of negotiated liberalization are well aware that
the benefits of open import markets do not depend on whether
other countries practice fair trade, however defined. Still, they
believe that the practical merits of a negotiated free-trade strategy
recommend it over the purer unilateralist position.
One frequently hears that unilateral free trade is simply "unrealis
tic. " Fully open markets in a protectionist world will never be
politically sustainable, according to that line of reasoning; the cause
of free trade at home can only advance if it is linked with pursuit
of free trade abroad.
The simpler version of the argument i s that public opinion would
never accept a policy of unilateral free trade. The American people's
sense of "fairness" would supposedly make them unable to tolerate
such a lopsided state of affairs. 4 That is less an argument than a
self-fulfilling prophecy. As long as people who know better refuse
to challenge the conventional-wisdom fallacies that underlie the
fair-trade worldview, the public will, of course, continue to be
suspicious of unrestricted import markets. It is the business of those
in the public-policy community to lead popular opinion, not to cave
in to it; passive acceptance (or worse, active repetition) of prevailing
misconceptions in the name of realism is an abdication of responsi
bility. 5
A more sophisticated argument uses public-choice analysis to
support its anti-unilateralist conclusions. The beneficiaries of pro
tectionism-domestic producers who face import competition
are concentrated, highly visible, and easily organized. By contrast,
the ultimate beneficiaries of free trade-consumers-are dispersed
and anonymous. Accordingly, in the rough-and-tumble of demo
cratic interest-group politics, there is a lobbying-power mismatch
3
For an elegant demolition of the fair-trade fallacy, see Bastiat, series 1, chap. 4.
4For a recent example of that kind of argument, see Irwin M. Stelzer, "The New
Protectionism," National Reie, March 16, 1992, p. 30.
sSee Leland B. Yeager and David G. Tuerck, "Realism and Free-Trade Policy,"
Cato Journal 3, no. 3 (Winter 1983-84): 65.
233
MARKET LIBERALISM
that favors the forces of protectionism. To counteract that imbal
ance, it is necessary to pursue free trade by indirection, through a
regional or multilateral trade-negotiations strategy. Such a strategy
enlists in support of free trade the lobbying muscle of the American
exporting interests that would benefit directly from foreign liberal
ization. 6
The above analysis fails to take into account the large and growing
extent to which the trade policy debate pits domestic protection
seeking producers not j ust against American consumers but against
other American producers as well. In a very real sense, all forms
of protectionism-even those directed against finished consumer
goods-come directly at the expense of some U. S. industry. In
addition to that, the percentage of U. S. imports accounted for by
capital machinery and equipment has risen dramatically over the
last 20 years, even as the presence of imports in the American
economy has generally been soaring. Imports as a percentage of
the gross national product of the United States rose from 4 percent
in 1970 to 9 percent in 1990, and during the same period, capital
goods as a percentage of total imports rose from 9 to 23 percent.
The competitiveness of American manufacturers depends increas
ingly on unimpeded access to foreign suppliers.
In addition, U. S. manufacturers are conducting more and more
of their production operations outside the United States. American
companies now produce an estimated 17 percent of their total out
put elsewhere in the world. The overseas affiliates of U. S. firms
frequently ship products back to the home country; approximately
18 percent of total U. S. imports are shipments from U. S. subsidiar
ies located abroad. 7
Thus, there i s a powerful and growing constituency of American
manufacturing interests with a direct stake in maintaining open
import markets. That constituency is beginning to make itself felt
in the political arena. The Coalition of American Steel Using Manu
facturers, led by Caterpillar, Inc. , lobbied strongly against import
6See, for example, Michael A. Walker, "A Canadian Vision of North American
Trade Integration," Paper presented at the Cato Institute and Centro de Investigaci
ones Sobre la Libre Empresa conference, "Liberty in the Americas: Free Trade and
Beyond," Mexico City, Mexico, May 19-22, 1992.
7DeAnne Julius, Global Companies and Public Policy: The Growing Challenge of Foreign
Direct Investment (New York: Council of Foreign Relations Press, 1990).
234
Trade Policy
restraints on steel and thereby helped to accelerate the demise of
the so-called voluntary restraint agreements. The U. S. computer
industry has had at least limited success in combatting import
barriers against Japanese semiconductors and flat computer
screens. A group of U. S. machine-tool manufacturers led by Hurco
Companies, Inc. , was being hurt, perversely enough, by import
limits on Japanese and Taiwanese machine tools; their lobbying
helped to cut extension of those limits from five years to two.
Regardless of what once may have been the case, there is no
longer necessarily a mismatch between the lobbying power of pro
tectionist and free-trade interests. Political leadership committed
unapologetically to eliminating import barriers would no doubt face
powerful opposition, but it could bring considerable muscle to the
fight. And as economic globalization continues, the potential
strength of the free-trade side will only increase.
It cannot be denied that, at present, unilateral free trade is politi
cally inviable. But the current state of affairs is not immutable.
Great Britain maintained a unilateral free-trade policy for a hundred
years. Hong Kong maintains one today. If they could do it, so
can we.
Encouraging Free Trade Abroad
The most powerful argument for negotiated liberalization (at least
from a free-trade perspective) is that while unilateral free trade may
be good, regional or worldwide free trade is even better. Granted,
import barriers harm our economy and should come down, but
why not kill two birds with one stone and get rid of other countries'
protectionist policies at the same time we dismantle our own? The
argument for negotiated liberalization looks good on paper, but
the facts tell a different story.
Consider the record of GATT, the worldwide trade organiZition
founded in 1947 that has been the central forum for negotiated
liberalization in the postwar era. GATT is widely credited with
helping to bring down tariff rates after World War II, but in more
recent years its accomplishments have flagged. In 1962 tariffs on
manufactured goods averaged 11. 5 percent in the United States,
1 1 . 0 percent in the European Community, and 16. 1 percent in
Japan. Today, all of those countries have average tariffs of around
5 percent. Cutting tariff rates of the major trading countries by
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MARKET LIBERALISM
5 to 10 percentage points over 30 years is not exactly dramatic
progress.
Meanwhile, all kinds of new non tariff trade barriers have
emerged. The Multifiber Arrangement constricts textile trade with
a cobweb of quota limitations. Voluntary export restraints have
curbed trade in steel, automobiles, consumer electronics, and
machine tools. Anti-dumping and countervailing duty laws impose
punitive duties on a wide variety of products in the name of fair
trade. Health and safety regulations are used surreptitiously to
block imports. And until now at least, GAT has never attempted
to impose discipline on protection of agricultural and services trade.
It is, therefore, hard to argue that the major industrialized coun
tries are less protectionist now than they were 30 years ago. Japan
has liberalized significantly during that time, but the United States
and the European Community are probably worse than they used
to be. And while many smaller and less developed countries have
slashed import barriers in the past decade, that liberalization has
occurred primarily because of shifts in internal economic policy,
not because of any constraints imposed by GATT. In sum, GATT
has been ineffectual in promoting world free trade.
GATT supporters had pinned their hopes on the current Urugua
y
round of talks to change all that. Negotiators put forward bold
proposals to extend GATT discipline to agriculture, textiles, ser
vices, investment, and intellectual property rights. At the time of
this writing, there is still some hope that the Uruguay round will
produce an agreement, but even if an agreement is reached, it
will be much more modest (and loophole filled) than originally
envisioned. Particularly within the industrialized world-which
still accounts for nearly 75 percent of world merchandise trade
there is no discernible prospect for significant liberalization as a
result of GATT negotiations.
In recent years, the United States has opened a second, regional
track for negotiated liberalization. In 1988 the United States entered
into a free-trade agreement with Canada, its largest single trading
partner; in 1992 the Bush administration negotiated NAFT A, which
expands the U. S. -Canadian agreement to include Mexico (as of
this writing Congress has yet to pass the legislation needed to
implement NAFTA, and it remains unclear whether Congress will
do so) . If NAFTA is enacted, supporters of regional liberalization
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Trde Policy
hope that the United States will move to enter into free-trade agree
ments with countries throughout Latin America.
Free-trade agreements can significantly liberalize trade between
and among the countries involved. With fewer countries involved
in the process, negotiations are more manageable and real break
throughs are possible. NAFTA, for example, would after 15 years
eliminate all tariffs on trade within the region, guarantee market
access in numerous service industries, and liberalize rules govern
ing foreign investment. Of course, free-trade agreements are far
from perfect: among other problems, NAFT A leaves intact the coun
tries' anti-dumping and countervailing duty laws, and it is marred
by arbitrary rules of origin that limit the products entitled to duty
free status.
The main problem with a regional free-trade strategy, though,
is its diminishing returns. Canada and Mexico together account for
about 28 percent of American exports and 24 percent of imports.
That is a significant chunk of U. S. trade, and one could argue
persuasively that pursuing regional negotiations up to the point of
NAFTA has been cost-effective in terms of liberalization gained
versus time and political energy expended.
Beyond NAFT A, however, there is a precipitous drop-off in the
utility of additional or expanded regional agreements. The entire
remainder of the Western Hemisphere accounts for only about 7
percent of L. >. exports and imports; Chile, the most logical candi
date for the next agreement, absorbs only 0. 4 percent of our exports
and produces only 0. 3 percent of our imports. While those numbers
would doubtless increase under liberalized trade, it is clear that
expanding NAFT A to encompass the entire hemisphere is an
exceedingly modest goal.
What about negotiating free-trade agreements with our major
trade partners, the European Community and Japan? Under the
reigning fair-trade political culture, such negotiations would be
either hopeless or exceedingly dangerous. The central issue in nego
tiations with the European Community would almost certainly be
the Europeans' massive subsidies to industry (e. g. , Airbus) and
agriculture. The record of the Uruguay round has demonstrated
that the European nations are not interested in seriously reforming
their subsidy policies; accordingly, negotiations would be dead
before they started.
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MARKET LIBERALISM
American dissatisfaction with Japan has less to do with explicit
protectionist policies than with the whole structure of the Japanese
economy. Those issues are far beyond the scope of trade negotia
tions, as shown by the farcical Structural Impediments Initiative.
Negotiators of a U. S. -Japanese agreement would be tempted to cut
the Gordian knot and simply decide on "acceptable" import and
export numbers; in the guise of a free-trade agreement, then, we
would actually be saddled with a managed-trade accord that set
market-share quotas for various sectors. Such an agreement would
be far worse than the mess we have now.
Whatever GATT's accomplishments in its very early years, and
whatever the qualified successes to date of regional free trade, the
future of negotiated liberalization looks decidedly bleak. Further
negotiations will at best mean marginal improvement, and they
could even make matters worse. Meanwhile, all our existing protec
tionist barriers are frozen in place as "bargaining chips, " with
reform outside the negotiations process rejected as "unilateral dis
armament. "
Furthermore, as mentioned earlier, trade negotiations rely on
and affirm the basic mercantilist assumptions that underlie protec
tionism. Thus, a trade-negotiations strategy helps to perpetuate a
hostile political culture, one that not only makes real liberalization
more difficult but also facilitates additional protectionism.
Negotiations place the focus of trade policy on the protectionism
of other countries, thus keeping the fair-trade mentality stocked
with an always-fresh supply of grievances. And there is no guaran
tee that the preferred method for settling those grievances will
always be negotiated liberalization. After all, once you concede that
reductions in U. S. import barriers should be conditioned on similar
reductions in other countries, it is difficult to resist calls for condi
tioning existing access to U. s. markets on liberalization abroad (as
in section 301 and "Super 301") or on favorable trade balances (as
in various proposals by Rep. Richard A. Gephardt) . Once unilateral
free trade is forsaken in favor of reciprocal free trade, the principle
of reciprocity can easily take on a life of its own, degenerating into
ever more aggressive and dangerous manifestations. 8
8For a critique of the trend i n L. b. trade policy toward threatening retaliation
against our trade partners unless they open their markets, see Jim Powell, "Why
Trade Retaliation Closes Markets and Impoverishes People," Cato Institute Policy
Analysis no. 143, November 30, 1990.
238
Trade Polic
Leading by Example
If the United States were to remove its own trade barriers and
convincingly renounce all future protectionism, what would be the
reaction of other countries? Would they, no longer fearing loss of
access to our markets, suddenly move to block American goods
from their own?
Not to worry. American goods and services are vitally important
and highly desired around the world. People in Japan, Germany,
France, Britain, Italy, South Korea, Taiwan, Hong Kong, and Singa
pore all import more goods per capita from the United States than
Americans import from those countries. It is really not conceivable
that the governments of those and other countries would be will
ing-in conditions short of war-to wreak the economic disloca
tions and personal hardship that would result from any signifcant
new impediments to purchasing American products.
Think of the reaction in this country if tomorrow 100 percent
duties were levied on all Japanese products, and suddenly Japanese
cars and televisions and radios and VCRs and computer chips and
laptops were twice as expensive as they are now. Now think of
Japan's doing the same to us, not in retaliation but because we had
opened our markets, and remember that while we buy gadgets
from them, they buy food from us. It just isn't in the cards.
If anything, the American adoption of a unilateral free-trade
policy would inspire the opposite reaction. In the past 10 years a
growing number of countries have made dramatic reforms in their
trade policies, replacing the old model of import substitution with
integration into the global economy. Bold moves toward freer trade
have been made by countries as diverse as Australia, New Zealand,
Mexico, Chile, Argentina, and India. Those countries have opened
their markets and welcomed foreign goods and investment, not
because of negotiating breakthroughs or U. S. threats, but because
their governments finally realized that autarky was causing eco
nomic stagnation. It was not outside pressure that carried the day,
but internal changes in perceived economic interest.
A U. S. policy of unilateral free trade would promote similar
reevaluations around the world. Open markets would improve our
economic performance and raise our standard of living, for all the
world to see. Instead of haggling with and browbeating our trading
partners to do what we say and not what we do, we would provide
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MARKET LIBERALISM
leadership by example. The power of that example would do more
to encourage free trade abroad than negotiations and international
organizations ever could.
Consider the European Community. Its members launched the
EC 1992 initiative of internal liberalization in the mid-1980s in
response to the doldrums of "Eurosclerosis. " In other words, the
European Community liberalized under the pressure of poor eco
nomic performance. If the United States were enjoying the benefits
of free trade, and the European Community's productivity and
growth were lagging behind ours, is it unreasonable to think that
the European Community might fnd free trade preferable to
becoming an economic backwater?
Getting There from Here
We do not write on a clean slate. Two major initiatives of negoti
ated liberalization-the Uruguay round and NAFTA-are now
entering their endgame after years of slow and tortuous progress.
The battle lines have been clearly drawn, and there is no sense in
trying to redefine them at this late stage. Both initiatives represent
true if limited progress, and both deserve the support of free-traders
for the remaining few months needed to decide their fate+
After that, supporters of open markets should forget about a
new round of GAIT talks, as well as extending NAFT A farther
south. Instead, free-traders should invest their energies and politi
cal capital in fighting trade barriers here at home. A president could
stake out a position as a bold leader and a friend of consumers and
economic progress by launching such an effort.
There is no shortage of inviting targets. The sugar and peanut
programs probably top the list for sheer disproportion between
benefit and cost. Textile quotas are a special-interest scandal: while
benefiting large and profitable companies, they act as a hidden
clothes tax that hits hardest those with the lowest incomes. The
anti-dumping law is economic nonsense that arbitrarily and unpre
dictably raises the cost of doing business in this country. One could
go on and on. 9
All of those programs would, of course, be defended by the
powerful and entrenched special interests that benefit from them.
9For a scathing attack on U. S. protectionist policies, see James Bovard, The Fair
Trade Fraud (New York: St. Martin's, 1991).
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Trade Policy
Victories, at least in the short term, would be difficult to come by.
But putting the special interests on the defensive-forcing them to
explain why they deserve to profit at the expense of the rest of
us-would in itself constitute a major victory. That is the immediate
advantage, and the ultimate key to success, to be gained by rejecting
negotiations in favor of unilateral free trade.
241
1+. Rethinking NATO and Other
Alliances in a Multipolar World
Christopher Layne
The new administration takes office at a time when international
politics has been radically transformed. Because the foreign policy
guideposts of the Cold War world have been swept away, the new
administration's initial challenge will be conceptual: it must break
away from the Cold War paradigm that still shackles American
foreign policymaking and rethink from the ground up the principles
that will define America's international political role in the
post-Cold War world.
The collapse of the Soviet Union and America's battlefield tri
umph in the Persian Gulf War gave rise to a burst of optimism
about the future of international politics. That attitude has been
encapsulated in the so-called new world order announced by Presi
dent George Bush. Accompanying the new world order was a
euphoric triumphalism based on three incorrect assumptions: ( 1)
i n the post-Cold War era the United States was-and would long
remain-the world's only great power (that is, the post-Cold War
world is unipolar); (2) by making the export of democracy the
central focus of its post-Cold War foreign policy, the United States
could bring about "perpetual peace" in international politics; and
(3) the Persian Gulf victory "proved" that the relative decline of
American power was a myth.
Far from forcing a sweeping reconsideration of America's world
role, the end of the Cold War reinforced the determination of those
who believe the United States should have a muscular foreign
policy-that is, a foreign policy that actively seeks to project abroad
America's power and its values. The view that America is "bound
to lead" the international system is deeply entrenched.
That view has precluded a reassessment of the means, as well
as the ends, of American policy, as is evident in the Bush adminis
tration's defense spending plans. Rather than availing itself of the
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MARKET LIBERALISM
Cold War's end to drastically reduce defense spending, U. S. offi
cialdom conjured up new threats to justify high levels of expendi
ture. To replace the obsolete mission of containing the Soviet Union,
the administration declared that the U. S. role now should be noth
ing less than preserving "peace and stability" in a post-Cold War
world characterized by "uncertainty, instability, and danger. "
Indeed, the foreign policy establishment believes the post-Cold
War world will be more dangerous for the United States than its
Cold War predecessor because of the proliferation of weapons of
mass destruction in hostile states, anti-American regimes in the
Third World, drug traffickers, anti-democratic insurgencies, and
terrorism. In the face of those dangers, it is said, America will need
to be more, not less, interventionist than it was during the Cold
War era. In this uncertain new world, officials contend, the United
States must maintain the same mix of forces (albeit somewhat
reduced in number) and the same military commitments (to Europe,
Japan, South Korea, the Philippines, Latin America, and Southwest
Asia) it did during the Cold War-notwithstanding that those alli
ances and forces were specifically tailored to contain the Soviet
Union. As Secretary of Defense Richard B. Cheney said in 1990:
"America should continue to anchor its strategy to the still valid
doctrines of deterrence, flexible response, forward defense [and]
security alliances . . . . Even the extraordinary events of 1989 do
not mean that America should abandon this strategic foundation. "l
The obvious question is, I f the collapse of the Soviet Union does not
provide sufficient incentive, just what would justify a fundamental
reassessment of America's grand strategy?
There is a striking dissonance between the static world view of
many policymakers and the objective realities that must sooner or
later shape American foreign policy. Before the gulf war, a new
"great debate" about America's place in the post-Cold War world
was just beginning. Central to that dialogue was Yale professor
Paul Kennedy'S cogent thesis that, as the preeminence of other
great powers in history had been lost, so America's economic
strength-and hence its geopolitical primacy-was being eroded by
I Richard B. Cheney, Statement to the Senate Budget Committee, February 5,
1990, Department of Defense typescript, p. 2.
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Alliances
its extensive, costly overseas military commitments.
2
That debate,
which was cut short by the gulf war, has not really been rej oined.
The issue of America's post-Cold War world role was not a major
issue in the 1992 presidential campaign, because Gov. Bill Clinton
consciously sought to occupy the middle ground by advocating a
world view and policies that in many respects were remarkably
similar to George Bush's. Given the McGovernite political baggage
carried by the Democratic party, Clinton's stance may have been
politically astute. But good politics does not always make good
policy. With the Cold War over, and with the gulf war's glow long
since faded, there is heightened awareness that the country faces
daunting challenges at home. Even some foreign policy establish
ment stalwarts (notably recently retired Foreign Afairs editor Wil
liam Hyland and New York Times columnist Leslie Gelb) have argued
that the United States should shift its priorities from foreign to
domestic policy. For that to happen, however, policymakers must
discard the Cold War mindset. To do that, they must understand
why the United States acted as it did after 1945 and why it does
not need to preserve an excessively activist strategy in the
post-Cold War era.
After World War II the world was bipolar both geopolitically and
ideologically. Cold War exigencies compelled the United States to
focus its energies on containing the Soviet Union. Because the other
pre-1939 great powers had been shattered by the war, only the
United States could counterbalance Soviet power and prevent the
expansion of Soviet influence. As part of its containment strategy,
America assumed worldwide military responsibilities, thereby
enabling the West European nations and Japan to pursue economic
recovery programs. Under the circumstances prevailing after World
War II, it was strategically j ustifiable for the United States to assume
the military and economic burdens imposed by containment.
The United States need no longer bear those costs, however.
Cold War constraints on the United States have been removed by
( 1) the Soviet Union's collapse and its successor states' preoccupa
tion with their overwhelming internal political and economic prob
lems, (2) the end of the Cold War in Europe following the collapse of
2
Paul Kennedy, The Rise and Fall of the Great Powers: Economic Change and Military
Confict from I 00 to Z000 (New York: Random House, 1987).
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MARKET LIBERALISM
Soviet power in East Central Europe, (3) the political and economic
recovery of Western Europe and Japan from World War II's devas
tating effects, and (4) the imminent emergence of Germany and
Japan as great powers.
The Mirage of a Unipolar World
The world today is temporarily unipolar, and U. S. officials want
to keep it that way. That was the thrust of the first draft of the
Pentagon's Defense Planning Guidance document for fiscal years
1994-99. That draft explicitly stated that the basis of post-Cold War
U. S. grand strategy should be nothing less than "deterring potential
competitors from even aspiring to a larger regional or global role. "3
Although the initial draft of the document was revised, under pres
sure, to delete that language, the revision was cosmetic only.
Indeed, the Bush administration repeatedly stated its belief that
the world is-and should remain-unipolar. Moreover, in the late
fall of 1992 the RAND Corporation and the Pentagon's joint staff
were engaged in drafting a "new NSC-68" -a grand strategic char
ter for U. S. policy in the post-Cold War world. That document
advocates a unipolar grand strategy and argues that a multipolar
system would constitute the worst of all possible geopolitical worlds
for the United States.
A policy of robust unipolarity, however, is not in America's
interest for two reasons: ( 1) it will produce a backlash against the
United States, and (2) it is beyond America's resources to sustain
a unipolar strategy. The single superpower concept is fantasy-land
foreign policy because it is based on the illusion of U. S. power and
ignores the decline of America' s relative power from its post-World
War II zenith. The desire to be the single superpower also fails to
recognize that new great powers will emerge, with or without
Washington's approval.
Japan and Germany already have the potential to become great
powers. To do so, they need only make a conscious political deci
sion to translate their potential power into actual great power. It
can be assumed that they will make that choice. Indeed, there is
3Patrick E. Tyler, "U. S. Strategy Plan Calls for Insuring No Rivals Develop," Ne
York Times, March 8, 1992, p. AI.
246
Alliances
plenty of evidence that they already are making it. 4 That develop
ment is unsurprising, because in the competitive realm of interna
tional politics, states tend to emulate their rivals. This is not the
first "unipolar moment" in international history. In the 1 660s
France was the only superpower in world politics, and in 1860
Great Britain was the sole superpower. In both instances, other
states responded to unipolarity by acquiring great power capabili
ties. In the late 1 7th century England and Austria emerged as great
powers; in the late 19th century Germany, Japan, and the United
States joined the ranks of the great powers. In both periods the
emergence of new great powers was a direct response to unipolar
ity. States strive to preserve their independence and their decision
making autonomy. For that reason, states capable of doing so (and
great powers always are) "balance" against the most powerful or
most threatening power in the system, or both, by forming coali
tions against it. States seldom "bandwagon" (go along) with the
most powerful or threatening state in the system. In other words,
states oppose hegemons. And by definition, the sole superpower
in a unipolar system is a hegemon, even if it views its hegemony
(as does the United States) as benign.
In any event, U. S. leaders will have to manage the unsettling
complexities of unipolarity (and the inevitable transition to multipo
larity) . But the diffculty of Washington's diplomatic task is exacer
bated by a policy that embraces unipolarity as a goal of American
foreign policy. Unipolarism is accompanied by the unbridled ambi
tion to forcibly reshape the world in America's image. Other nations
find that threatening. Although Bush administration officials
asserted that other nations "trust" the United States as the sole
superpower, there is overwhelming evidence that they do not.
Indeed, the need to counterbalance unchecked American power is
a theme increasingly voiced in Europe, Japan, and the Third World.
A unipolar strategy will only hasten the emergence of the very
world its advocates seek to prevent. The new administration should
realize that a unipolar world is unattainable and undesirable. A
4For evidence of this and fuller consideration of unipolarity's theoretical implica
tions and policy consequences, see Christopher Layne, "Will New Great Powers
Rise? A Neorealist Critique of the Unipolar Moment," International Security, March
1993, forthcoming.
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MARKET LIBERALISM
multipolar world is inevitable. Although such a world poses certain
risks for the United States, it also offers many opportunities.
The current fixation on unipolarity contrasts unfavorably with
the views of the principal architects of America's post-World War
II policy-Secretary of State George C. Marshall and State Depart
ment Policy Planning Staff Chief George F. Kennan. Kennan real
ized that in a bipolar world, the United States would be overtaxed
because it would have to bear singlehandedly containment's bur
dens. In a multipolar world, however, there would be other power
centers with which the United States could share security responsi
bilities. It was, therefore, Marshall's and Kennan's goal to restore
a multipolar balance of power. Today, the world is on the threshold
of multipolarity, but instead of reaping the benefits of that change,
the United States is resisting it.
Beyond NATO
The new administration will need to cast off the old self-defeating
policy, and Europe is the place to begin. The Soviet Union's collapse
has left NATO with no obvious raison d'etre. However, instead of
writing off the alliance as a Cold War relic, the American foreign
policy establishment has advanced numerous new rationales to
.justify it.
Washington clings to NATO because it views the alliance not
only as a mechanism for American supremacy in European security
affairs but also increasingly as the only means of ensuring that the
United States still has a voice in Europe's diplomacy. That view
ov'erlooks an important fact: as America' s power has declined,
Europe's has inevitably increased. Consequently, Europe has
become more assertive in defining its policies independent of Wash
ington's tutelage. Europe is simply no longer willing to take a
back seat to the United States in matters affecting its interests. Put
another way, U. s. infuence in European affairs will inexorably
diminish, given the shift in the relative power relationship.
A second erroneous justification for keeping NATO intact is the
"leverage strategy. " Articulated by President Bush and Harvard
professor Joseph S. Nye, Jr. , among others, the leverage strategy
assumes the United States can use its power to extract concessions
from Western Europe and Japan in international economic and
financial negotiations. The leverage strategy became offcial policy
248
Alliances
in the spring of 1992 when the Bush administration linked continua
tion of the American commitment to NATO to European Commu
nity concessions in the General Agreement on Tariff and Trade
negotia tions.
There are two points to be made about the leverage strategy.
First, it was largely unsuccessful even during the Cold War, when
Western Europe (and Japan) presumably were heavily dependent
on American security guarantees. Now that the Cold War's end
has devalued America's security commitments, why should it be
expected that Western Europe and Japan will make economic and
financial concessions to obtain (largely unneeded) American protec
tion? Second, the leverage strategy-espoused by those who most
vehemently dispute that American power has declined-is itself a
damning confession of decline. The underlying assumption of the
leverage theory is clear: the United States must use its military
power to coerce Western Europe and Japan because its economic
and financial strength alone is no longer adequate to secure accept
able outcomes in international negotiations with those two centers
of power.
Another line of defense for NATO is the argument that "bad
things" will happen unless the United States keeps the peace
throughout Europe. For example, it has been contended that if
events in Eastern Europe spiraled out of control and precipitated
a general European war, the United States would be devastated
economically by the disruption of transatlantic trade. In addition,
NATO partisans insist that such a conflict could leap the Atlantic
and draw the United States into a nuclear engagement.
A great power war in post-Cold War Europe seems unlikely but
cannot be ruled out. Such a war would obviously have an adverse
effect on the United States because Europe is an important export
market. Nevertheless, the United States is not heavily dependent
on European markets. America has a huge domestic market (.which
may increase if the North American Free Trade Agreement is rati
fied) and diversified overseas markets. Moreover, the possible loss
of trade occasioned by a future European war must be measured
against the likelihood that such a war would indeed occur and
weighed against the very real costs of preparing for (and the antici
pated costs of waging) such a war.
The fear that a European nuclear war could engulf the United
States is also misplaced. If America were not party to a European
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MARKET LIBERALISM
great power war, and if U. S. forces were not in Europe, it is difficult
to foresee how the United States could be drawn in. In fact, no
one has advanced a plausible scenario to explain how a European
war could "leap the Atlantic" if the United States were uninvolved
in the initial conflict. Conversely, the American military presence
in Europe carries with it the risk of U. S. involvement in a European
conflict. Indeed, the U. S. commitment virtually ensures that the
United States would be swept up into a maelstrom of spreading
violence if a local European conflict did escalate into a major war.
In post-Cold War Europe, military involvement, not aloofness,
poses the risk to American security.
One of the most pernicious myths pervading American foreign
policy is that all European wars invariably affect vital U. S. security
interests. That is simply untrue. Great power wars in Europe
erupted in 1792, 1803, 1854, 1866, 1871, and 1878 without having
any discernible impact on U. S. interests. Only three times have
Europe's major conflicts entangled the United States, and in each
case there were extenuating circumstances. The first occasion was
the War of 1812. Although connected tangentially to the Napoleonic
Wars, the War of 1812 was rooted in long-standing Anglo-American
tensions, including the desire of U. S. war hawks to conquer Can
ada. Indeed, the United States began hostilities by declaring war
on Great Britain.
America's involvement in World War I was driven by misguided
Wilsonian crusading zeal, not by any tangible threat to American
security. Even if Germany had triumphed in World War I, the
European balance of power would have merely been altered. It
would not have been shattered, and Germany would not have been
in a position to mobilize all of Europe's resources to challenge the
United States. In all likelihood, however, Germany would not have
won the war even in the absence of American involvement. In early
1917 the major belligerents recognized that the military deadlock
was unlikely to be broken, and they began to contemplate the
pOSSibility of a negotiated peace. Ironically, the prospect of Ameri
can military intervention-and with it the hope of victory-was
probably the key factor that led the British government to decide
against pursuing a compromise peace. Had the European powers
been able to end the war diplomatically, the great upheavals of
1918-19 that destabilized East Central Europe-and sowed the
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Alliances
seeds for Hitler's rise to power-might have been avoided. The
flawed post-I918 peace treaties (largely Woodrow Wilson's handi
work) had baleful effects that still bedevil Europe, most notably
Yugoslavia.
The third occasion was U. S. involvement in World War II. It
would have been both diffcult and risky for the United States to
have remained aloof from that conflict after Germany subdued
France and drove British forces from the Continent. The control of
Europe's population, industrial capabilities, and resources by an
aggressively expansionist state that already possessed a world-class
military would have posed a serious threat to America's own secu
rity. Such circumstances, however, bear no resemblance whatso
ever to present conditions in Europe.
The official rationales for preserving NATO do not hold up,
but there is another reason often voiced by policymakers-though
always off the record-for preserving NATO: fear of Germany. 5
As a practical matter, however, it is hard to see how NATO could
be used to contain Germany, which is the alliance's most powerful
and important European member. Moreover, from a policy stand
point, a U. S. policy that sought to constrain Germany would be
unwise. The United States cannot prevent Germany from becoming
a great power, and any attempt to thwart Germany's emergence
as a great power would be resented by most Germans. Because
American influence in post-Cold War Europe will hinge largely
on the quality of Washington's relations with Berlin, it would be
counterproductive for the United States to allow itself to be drawn
into schemes that have the real-if unstated-goal of hemming in
Germany.
The architects of America's post-World War II foreign policy
never envisioned NATO as a permanent fixture in transatlantic
relations. They wanted to protect a war-ravaged Western Europe
while it regained its political, economic, and military strength-at
which point Western Europe would assume responsibility for its
5Nongovernmental supporters of NATO are less shy about explicitly citing the
containment of Germany rationale. See, for example, James Chace, Consequences of
the Peace: The New Internationalism and American Foreign Policy (New York: Oxford
University Press, 1992), pp. 68-69; William E. Odom, "The German Problem: Only
Ties to the United States Provide the Answer," Orbis 34 (Fall 1990): 483-504; and
Leslie H. Gelb, "Power in Europe," New York Times, October 20, 1991, p. E15.
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own defense. Much of the current American foreign policy estab
lishment has forgotten what NATO was all about. Preserving the
alliance has become an end in itself.
To preserve the alliance, U. S. policymakers have acquiesced to
a dangerous shift in NATO's strategic mission. Historically, the
United States had one overriding security interest in Europe: pre
venting a single power from establishing control over the Conti
nent. Such a power could then have conceivably threatened the
United States directly. However, with the Soviet Union's collapse,
the threat of a European hegemon has receded. That does not mean
that post-Cold War Europe will be peaceful. Events in Yugoslavia
have amply shown that in East Central Europe and the Balkans
unresolved national, ethnic, and religious disputes pose a real risk
of armed conflict. Such conflicts are local in nature, however, and
they are unlikely to have any ramifications for the European or
global balances of power. In short, they do not affect tangible Amer
ican interests, notwithstanding the near hysteria of those who
advance highly implausible "parade of horribles" scenarios to jus
tify U. S. intervention in the turmoil in the Balkans.
Yet NATO has adopted as its new strategic mission the conduct
of peacekeeping and peacemaking operations in such places as
Bosnia-Hercegovina, Nagorno-Karabakh, and Moldova. 6 Domino
type thinking (if we don't intervene in Bosnia, other peoples in
Europe will use violence to resolve their disputes") and misguided
moralism threaten to inject the United States via NATO in Europe's
future quagmires. The new administration should rethink the alli
ance's role and not allow itself to be seduced by those arguments.
The various conflicts in East Central Europe, the Balkans, and the
former Soviet Union are discrete, not linked, events. NATO inter
vention in any one dispute is not going to have any meaningful
deterrent effect on disputes elsewhere. Moreover, the conflicts in
those volatile regions are not amenable to resolution by outside
intervention.
&he policy adopted by the NATO foreign ministers at their June 1992 meeting
in Oslo that would make alliance forces available for peacekeeping operations author
ized by the Conference on Security and Cooperation in Europe certainly creates
that danger. William Drozdiak, "NATO Widens Mandate on Forces," Washington
Post, June 5, 1992, p. A41 .
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Alliances
It is probably an illusion to believe that U. S. military involvement
in the Balkans and other unstable regions could be limited. Ameri
can policymakers became involved in Vietnam by gradual steps,
and no one envisioned that those steps would lead ultimately to a
conflict in which more than 500,000 U. S. troops would be engaged.
Incremental commitments generate momentum for even greater
involvement. Once a government makes a commitment, its credibil
ity, reputation for resolve, and prestige are on the line, and it
becomes increasingly difficult to disengage. Whether NATO inter
vention in East European ethnic conflicts would lead to another
Vietnam is an open question; that such involvement would at least
lead to new Lebanon-type situations is beyond dispute. Even the
U. S. military exhibits little enthusiasm for performing the regional
intervention tasks required of it under NATO' s new strategy. The
prudence of the military leadership contrasts sharply with the rash
interventionist sentiments expressed by many pundits and civilian
analysts.
It is time to rethink America's commitment to NATO. Washing
ton's obligations to the alliance entail significant risks. The threats
in Europe are now much more diffuse than was the case during
the U. S. -Soviet standoff, which at least had the virtue of being
predictable. Instead of protecting vital U. S. security interests,
NATO has become a means for entangling the United States in
Eastern Europe's intractable internecine quarrels. The possibility
of intervention in Yugoslavia underscores the danger. Aside from
the cost of America's NATO obligations-at least $90 billion a
year-the danger of such entanglements is reason enough to termi
nate the association. 8
Terminating the East Asian Protectorates
It is also time to rethink America's other overseas alliances, espe
cially Washington's commitments to Japan and South Korea that
7
The views expressed by Chairman of the Joint Chiefs of Staff Gen. Colin Powell
are an example. Michael R. Gordon, "Powell Delivers a Resounding No on Using
Limited Force in Bosnia," Ne York Times, September 28, 1992, p. AI.
80n the cost of Washington's NATO obligations, see Earl C. Ravenal, Designing
Defense for a Ne World Order: The Military Budget in I JJZ and Beyond (Washington:
Cato Institute, 1991), p. 51.
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cost American taxpayers nearly $40 billion a year. Those tWo alli
ances are vestiges of the Cold War and are irrelevant to the emerging
international security environment. Both treaties have the
unhealthy effect of trying to perpetuate the dependence of increas
ingly capable powers on the United States for their defense needs.
Japan has long been capable of providing for its own defense
if it were willing to make the effort and if the United States did
not consistently discourage independent Japanese initiatives. Japan
today has the world's second largest economy as well as one of
the most dynamic and sophisticated. Yet Japan spends a mere $33
billion a year on defense while the United States spends more than
$280 billion.
A similar situation exists with regard to South Korea. When the
United States signed the "mutual" security treaty with Seoul, South
Korea had been devastated by war and faced an aggressively expan
sionist North Korea backed by both the Soviet Union and China.
Today, however, South Korea is an economic dynamo that com
petes in a host of international markets. It has twice the population
and an economy nearly 11 times as large as that of North Korea.
Furthermore, Moscow and Beijing are both busy cultivating exten
sive diplomatic and economic ties with Seoul. Their actions are not
surprising since South Korea has much to offer both countries while
North Korea is an economic and political liability. Neither Russia
nor China shows any interest in fomenting a new war on the Korean
Peninsula; indeed, such a confict would be utterly contrary to their
best interests. Under such conditions, South Korea no longer needs
to be a military protectorate of the United States.
U. S. relations with Japan will be crucial in coming decades.
Within the first decade of the 21st century, Japan's economy may
even overtake America's as the world's largest. As Paul Kennedy
has shown, time and again in international politics, shifts in relative
economic standing have heralded the rise of new great powers that
one day would have a decisive impact on the military and territorial
order. The shift in the relative economic power of the United States
and Japan is, therefore, of potentially enormous geopolitical sig
nificance.
Japan's rise to great power status presages a much more difficult
relationship between Washington and Tokyo. Although skillful
diplomacy on both sides might ameliorate tensions, history sug
gests the existence of a "Hertz-Avis" dynamic that pushes the
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Alliances
two leading powers in a multipolar system into competition. The
pre-World War I Anglo-German rivalry is an example of that phe
nomenon. For that reason, it could be argued that rather than
terminating the Mutual Security Treaty with Japan, the United
States should continue to protect Japan in the hope that doing so
will remove incentives for Tokyo to acquire great power capabilities.
Although superficially appealing, that argument i s gravely flawed
because ( 1) the United States cannot prevent Japan's emergence as
a great power, and (2) an American policy that tried to do so
would serve only to antagonize Japan and make it more difficult
to construct a stable U. S. -Japanese relationship. 9
Another argument against terminating U. S. military commit
ments in East Asia is that to do so would "destabilize" the region.
In particular, many people point to the fears of other Asian coun
tries that an Amrican pullback would lead to increased Japanese
power. No doubt, if a new U. S. strategy forces Japan to internalize
its security costs and expand its military forces, regional arms races,
rivalries, and "instability" may result as the other East Asian
nations move to offset Japan's influence and create a regional bal
ance of power. That would not necessarily be to America' s disad
vantage, however. By adopting an offshore balancer's strategy, the
United States would actually reduce the likelihood of a confronta
tion with Tokyo, because Japan would also have to concern itself
with China, Korea, and Russia. By relearning how to be a strategic
balancer in a multipolar world, the United States can both protect
its vital interests and dramatically lower its military expenditures.
And if the new administration is serious about revitalizing the
American economy, it will need to devise a new grand strategy
predicated on the inevitability of much smaller defense budgets
and a dramatic restructuring of overseas security commitments.
Toward a Post-Cold War Strategy
With the passing of the Cold War and the Soviet threat, there is
no reason for the United States to persist in a policy that allows its
allies to externalize their security costs by shifting them to this
country. That underscores a fundamental point with which the
9por a discussion of that danger, see Ted Galen Carpenter, A Search for Enemies:
America's Alliances after the Cold War (Washington: Cato Institute, 1992), chap. 2.
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new administration will have to come to terms: at a time of declining
economic competitiveness and fiscal insolvency, the opportunity
costs of NATO and America's other alliances are very high. If the
new administration truly wants to revitalize America, it must begin
by redefining U. s. foreign policy. Foreign policy and domestic pol
icy are interconnected. No one can reasonably doubt that America
today would be more competitive economically, more prosperous,
and more tranquil if, over the past 47 years, the money underpin
ning foreign policy had been available instead for some mix of
the following: growth and investment stimulating tax reductions,
inflation-reducing deficit reductions, civilian research and develop
ment, education, infrastructure restoration, and other important
components of domestic economic progress. Yet few Americans in
or out of government seem to understand that many of our current
economic troubles are directly attributable to thecosts (direct and
indirect) of Washington's post-World War II foreign policy.
To adopt a radically different foreign policy, it is necessary to
demolish the intellectual foundations upon which post-1945 U. S.
foreign policy was based. I t i s also vital to understand that the key
trends in world politics-especially the emergence of a multipolar
system of at least four great powers-makes it possible for the
United States to stop being the world's policeman without sacrific
ing its vital security interests. America is not bound to lead in world
affairs, and increased "instability" (a mushy term the meaning and
implications of which must be more rigorously defined) and chaos
are not the inevitable (or even likely) alternatives to U. S. global
preeminence. Unlike other great powers throughout history, the
United States has the freedom to choose its security interests.
Because of the interlocking factors of geography, nuclear weapons,
and still impressive military and economic capabilities, the United
States has choices that other nations lack. For 50 years America
has opted, at considerable cost to its own domestic well-being, to
put the interests of the international system first. Now it is time
for a new foreign policy that puts America's interests first. A com
pletely restructured U. S. foreign policy would include the following
measures .
A policy of strategic retrenchment that would alleviate America's
foreign policy burdens by devolving security responsibilities to
the emerging great powers and important regional powers.
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Alliances
A new U. S. foreign policy that strives for burden shifing, not
merely burden sharing. Direct U. S. military involvement in over
seas crises would be a last, not a first, resort. Accordingly, it
would be possible to make deep cuts in U. S. conventional forces.
Strategic retrenchment would enable the United States to shift
its resources and energies from foreign to domestic policy.
A prompt reduction of U. s. forces in Europe to headquarters
and logistics units for one corps and supporting air power. Upon
the complete withdrawal of Russian forces from Germany, all
American forces should also be withdrawn.
Encouragement of initiatives, such as the formation of the Franco
German corps, to develop an independent European defense
capability.
Abrogation of the U. S. -Japanese mutual defense treaty, and
return of American forces presently stationed in Japan to the
United States within five years. The same policy should be
adopted with regard to the U. S. -South Korean alliance.
Immediate formation of a high-level study group tasked with
reviewing U. S. foreign policy commitments and developing a
grand strategic posture consistent with America's interests in the
post-Cold War world.
The new administration should reject a unipolar grand strategy.
Such a strategy is based on the illusion, not the reality, of American
power. Simply put, the United States lacks the resources to sustain
its self-appointed role as the arbiter of world affairs. America's
relative economic power-the foundation of its strength as a great
power-has eroded from its post-World War II apogee. Proponents
of the unipolar strategy also fail to understand that new great
powers will emerge regardless of Washington's wishes or its poli
cies. Recent U. s. strategy has been based on the erroneous assump
tion that other states welcome American dominance in world poli
tics. They do not, and balancing against excessive U. s. power is
already occurring. The fatal paradox of the unipolar strategy is this:
it will actually accelerate the emergence of new great powers and
lead to increasing resistance to American policies rather than to
the extension of American influence. Proponents of the unipolar
strategy overlook a basic point: although the United States would
be adversely affected by unipolarity, it is uniquely positioned to
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benefit from a multipolar world. Such a world presents the opportu
nity to return to a more traditional geopolitical role, to shift security
burdens to others, and to turn America's focus from the illusory
pursuit of world order to the imperative goal of renewal at home.
258
1. Learning to Live with Nuclear
Prolifera tion
Ted Galen Carpenter
The proliferation of nuclear weapons is likely to be one of the
most serious security problems for the United States in the
post-Cold War era. The U. S. -led international nonproliferation sys
tem, represented by the 1968 Nuclear Nonproliferation Treaty
(NPT), is showing signs of serious strain. With the breakup of
the Soviet Union, at least four of the successor republics (Russia,
Ukraine, Kazakhstan, and Belarus) will have nuclear weapons
deployed on their territory for the next several years. Although the
last three countries have agreed to ultimately become nonnuclear
states, there is mounting domestic opposition to that step because
it would give Russia a regional nuclear monopoly.
Even before the disintegration of the USSR, an ominous prolifera
tion trend was evident. Israel has had an arsenal (albeit not officially
acknowledged) of 100 to 300 weapons since the 1970s. Most experts
believe that India and Pakistan either have small arsenals or can
acquire them on short notice. Following the end of the Persian
Gulf War, UN inspectors discovered Iraq's surprisingly advanced
nuclear-weapons development program, and reports have surfaced
that nearly a dozen nations including Iran, North Korea, and Libya
have active programs. l True, there have also been some favorable
developments-such as South Africa's decision to abandon its pur
suit of an arsenal and sign the NPT and indications that North
Korea may be reconsidering its options. 2 Nevertheless, it seems
certain that there will be a larger number of nuclear-armed states
in the future than there are at present.
IThe best discussion of long-term proliferation trends is Leonard S. Spector with
Jacqueline Smith, Nuclear Ambitions (Boulder, Colo. : Westview, 1990).
2
For a cautiously optimistic assessment of such developments, see
Leonard S. Spector, "Repentant Nuclear Proliferants," Foreign Policy 88 (Fall 1992):
21-37.
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Unfortunately, U. s. officials seem to be in a state of denial about
the implications of an increasingly multipolar nuclear environment;
they are clinging reflexively to a nonproliferation system that is
becoming less and less viable. There is an urgent need for a compre
hensive reassessment of U. S. policy. Moreover, policymakers have
to accept that there are no perfect solutions to the proliferation
problem-only a difficult choice among unpleasant alternatives.
Three options appear to be available to the United States: a "status
quo plus" policy, coercive nonproliferation, and adjustment to pro
liferation. 3
Status Quo Plus
Almost by intellectual default, the United States is pursuing a
status quo plus policy. U. S. offcials believe that the NPT has been
a great success and thereby made the world a much safer place
than it would have been without a concerted international strategy
to prevent the spread of nuclear weapons. The operating assump
tion of U. s. policymakers appears to be that although the NPT
system is now under siege from a variety of sources, it is still
working well. They point to the recent decisions by France and
China to sign the NPT, thus bringing all five of the official (declared)
nuclear powers under the jurisdiction of the treaty, as evidence of
success. Washington's policy, in their view, should be a redoubled
diplomatic effort to strengthen the existing nonproliferation regime.
One of the most difficult tasks for statesmen is knowing when
events have overtaken a successful policy and rendered it obsolete.
The argument can be made that a nonproliferation strategy served
American security interests effectively in the past. As the preemi
nent nuclear power, the United States understandably sought to
prevent proliferation. Ideally, the United States would have liked
to have preserved the atomic monopoly that it possessed at the
end of World War II. When it proved impossible to do so after the
USSR exploded an atomic device in 1949, Washington adopted the
next best goal-limiting the number of nations that would have
nuclear weapons. It was the emergence of both France and China
3For a more detailed discussion of those options, see Ted Galen Carpenter, "A
New Proliferation Policy," National Interest 28 (Summer 192): 63-72.
260
Nuclear Proliferation
as uninvited members of the previously exclusive global nuclear
weapons club that impelled Washington to try to codify its nonpro
liferation policy in the NPT.
Given the realities of the Cold War, Washington's enthusiasm
for the virtues of nonproliferation made sense. A starkly bipolar
international system dominated by two nuclear-armed states
imposed a stable balance of terror. Any acquisition of nuclear weap
ons by other actors in the international system, however, automati
cally weakened the ability of the superpowers to "manage" conficts
and keep the rivalry within bounds. In exchange for its allies' will
ingness to forgo nuclear weapons, the United States extended to
them the protection of the U. S. strategic arsenal. That was the
fundamental bargain underlying Washington's doctrine of
extended deterrence. 4 Without such protection, even such influen
tial nonnuclear states as West Germany and Japan would have
been vulnerable to Soviet intimidation, given the USSR's nuclear
trump card.
From Washington's perspective, the combination of nonprolifer
ation and extended deterrence served American interests. True,
the United States was committed to deterring a Soviet attack on
various "free world" nations that had become U. S. protectorates.
But an implicit set of rules gradually emerged to govern the super
power rivalry, and as time passed it seemed less and less likely
that the Kremlin would ever take a reckless gamble that might
plunge the world into nuclear conflict.
Because those policies succeeded in a Cold War setting, U. S.
officials may have drawn some erroneous conclusions. Instead of
regarding nonproliferation and extended deterrence as useful (or
at least tolerable) policies under a set of conditions peculiar to a
bipolar world, they assume that both policies have enduring value
and are thus sacrosanct. Washington's insistence on preserving
extended deterrence and strengthening the NPT in a vastly different
post-Cold War era is a prime example of retrograde thinking.
There are two serious problems with pursuing a status quo plus
policy. The first and most obvious is that more and more nations
he linkages among alliance commitments, extended deterrence, and the con
figuration of the U. S. strategic arsenal are described in Earl C. Ravena!, "Counter
force and Alliance: The Ultimate Connection," International Security 6 (Spring 1982):
263.
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have the ability to acquire, and apparently the intention of acquir
ing, nuclear weapons. Rudimentary nuclear technology is now
nearly five decades old, and it is unrealistic to assume that only a
small number of advanced industrial states will have the requisite
technology or know-how to build a bomb. More than two genera
tions of Third World scientists and engineers who have been edu
cated at some of the finest Western (or Soviet) universities can
put their expertise at the disposal of governments determined to
develop nuclear weapons. Although much information on nuclear
technology remains classified, there has been some leakage, and a
good deal of pertinent information has legally found its way into
the public domain.
And it is possible to get the fissionable material needed to build
a bomb. Israel apparently built its arsenal using material it obtained
illegally from U. S. and other Western sources. True, it may have
been easier for Israel to engage in such surreptitious conduct
because it is not a signatory to the NPT. The International Atomic
Energy Agency (IAEA) does theoretically have rigorous inspection
requirements to prevent the diversion of fissionable material by
treaty members who build reactors for electric power or other peace
ful purposes. NPT signatories with advanced nuclear technology
are also supposed to make diligent efforts of their own to prevent
any diversion when they assist other nations in building or operat
ing reactors. Nevertheless, the case of Iraq demonstrates clearly
that those safeguards have been ineffective. The IAEA conducted
repeated inspections of Iraq's "peaceful nuclear research program"
for several years before the onset of the Persian Gulf crisis without
detecting the underlying nuclear-weapons effort.
The leakage of both nuclear technology and the material for
weapons is likely to accelerate. There are thousands of nuclear
weapons in the former Soviet Union, and the political turmoil there
hardly promotes optimism about effective control. A wealthy gov
ernment could conceivably acquire a fully operational small arsenal
without having to go through the time-consuming process of creat
ing its own weapons development project. Even if such an egre
gious leak does not take place, there are thousands of Soviet nuclear
scientists and engineers whose employment prospects are uncer
tain in the new Commonwealth of Independent States (CIS) . Gov
ernments that want to become nuclear-weapons powers are likely
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Nuclear Proliferation
to offer both better job security and higher incomes than the CIS.
It is reasonable to assume that at least some scientists and engineers
will succumb to temptation. 5
The nature of the post-Cold War international system also
increases the incentives for various powers to acquire independent
arsenals. Regional disputes that were often submerged during the
long rivalry between the United States and the Soviet Union are
now resurfacing. Moscow clearly no longer has the ability to keep
its one-time allies and clients in line, and even Washington's ability
to control its allies and clients has begun to wane. In a Cold War
setting, Pakistan, for example, was hesitant to defy the United
States, even though Washington's policy preferences might some
times inhibit Islamabad's ability to deal with its principal adversary,
India. No Pakistani government wanted to anger Washington to
the point that it would lose U. S. protection and be vulnerable to
Soviet pressure or aggression. But with the dissipation of the Soviet
threat, that restraint is far weaker and the focus on the "India
threat" much more pronounced. During the Cold War, the United
States at least made it difficult for Pakistan to pursue its nuclear
,
ambitions; in a post-Cold War setting, Washington does not have
the same political leverage.
The likelihood of nuclear proliferation means that a status quo
plus policy will not be sustainable. It also casts doubt on the wisdom
of the corollary doctrine of extended deterrence. Indeed, by clinging
to those two doctrines, Washington risks creating the worst of
alI possible situations for the United States. The nonproliferation
system is producing a perverse result: the regimes that are the most
determined to acquire nuclear weapons are in many cases the same
ones that the United States and the world community would least
like to see have them. Just as domestic gun control laws are fairly
effective at taking guns out of the hands of people who would
never use them for criminal purposes, while doing little to prevent
hardened criminals from obtaining them, the NPT persuades the
Italys, Swedens, Venezuelas, Japans, Australias, and South Koreas
of the world not to acquire nuclear weapons. Unfortunately, it is
som Clancy and Russell Seitz, "Five Minutes Past Midnight, " National Interest
26 (Winter 1991-92): 3-13.
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having progressively less ability to dissuade the Irans, Libyas, and
North Koreas from doing so.
The differential impact of the NPT along with Washington's con
tinued adherence to extended deterrence are creating a deadly com
bination. If U. S. policy does not change, the United States will find
itself in the position of having to shield an assortment of nonnuclear
allies from a rogues' gallery of nuclear-armed adversaries. That
would be a more diffcult and ultimately a more dangerous mission
than was shielding those allies from Soviet aggression during the
Cold War. Washington always operated under the assumption that
although the Kremlin might be ruthless and brutal, it was rational
and not unduly reckless. U. S. leaders cannot as confidently assume
rationality in an adversary such as Saddam Hussein, Muammar
Qadaffi, Kim II Sung, or Iran's Shi'ite fundamentalist regime. That
is especially true if the United States is attempting to deter an attack
by one of those regimes on a hated regional ideological or religious
opponent. By continuing to discourage allies from acquiring inde
pendent deterrents while keeping the doctrine of extended deter
rence intact, the United States is placing itself on the front lines of
regional disputes that could easily go nuclear, and it is attempting
to deter regimes that may be undeterrable.
Coercive Nonproliferation
Some members of the foreign policy community, sensing that
the old nonproliferation system with its emphasis on diplomatic
cooperation and technology controls is losing its effectiveness, have
begun to advocate a new, more coercive form of nonproliferation. In
its extreme manifestations, that strategy is based on Washington's
willingness to launch preemptive military strikes against the
nuclear installations of "undesirable" regimes. Proponents see the
"Osirak option" -referring to the Israeli air strikes against a reactor
outside Baghdad in 1981-as the appropriate model.
More sophisticated versions of a coercive nonproliferation strat
egy view preemptive strikes as a last resort, preferring instead to
focus on strengthening the IAEA's inspection authority-including
the power to conduct unannounced inspections without the con
sent of the suspected government-and imposing more effective
26
Nuclear Proliferation
diplomatic and economic sanctions on violators of the NPT.
6
They
also typically prefer an international effort directed by the UN
Security Council to a unilateral policy enforced by the United States.
There are several problems with a strategy of coercive nonprolif
eration. In its milder incarnation, the approach does not differ
materially from the status quo plus policy, and it shares most of
the defects and limitations of that policy. For example, although
more intrusive IAEA inspections may seem to be a worthwhile idea
in the abstract, it has very little meaningful substance. The regimes
that would support unimpeded inspections are not likely to be the
ones pursuing clandestine nuclear-weapons programs. Proponents
would still face the problem of inducing recalcitrant governments
to consent. At the very least, that would require the imposition of
economic sanctions. It is not an inspiring scenario, since sanctions
have not had an impressive record of persuading target regimes
to make concessions on important issues.
That realization leads most proponents of coercive nonprolifera
tion back to the ultimate coercive mechanism: military force. Politi
cal scientists William H. Lewis and Christopher C. Joyner acknowl
edge that a willingness to use force must undergird other measures
to stem the spread of nuclear weapons.
How the international community comes out on that deci
sion will tell much about the real prospects for international
arms control. Moreover, it will clearly signal whether inter
national arms control efforts will be backed up by serious
military sanctions carrying the international consensus and
a real bite, or whether such efforts will persist as sporadic,
piecemeal, stop-gap measures in an increasingly complex,
interdependent world order.
Using military force to preserve the crumbling nonproliferation
system has some serious drawbacks. One of the most basic difficul
ties would occur if attacks were made on operating reactors. Such
ee John Simpson and Darryl Howlett, "Nuclear Nonproliferation: The Way
Forward, " Survival 23 (November-December 1991) : 491-93; Gary Milhollin and
Gerard White, "Stop the Nuclear Threat at the Source," Ne York Times, August
16, 1991; and William H. Lewis and Christopher C. Joyner, "Proliferation of Uncon
ventional Weapons: The Case for Coercive Arms Control," Compartive Strateg 10
(Fall 1991): 299-309.
7Lewis and Joyner, p. 309.
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attacks could easily produce a major leak of radiation that would
pose a danger not only for citizens in the target country (which
would be bad enough) but for people in neighboring states as
well. There are also more subtle dangers and problems. One of
the lessons learned by would-be nuclear-weapons states from the
Israeli raid on the Osirak reactor was the need to make their pro
grams as clandestine as possible. The Osirak facility had been duly
registered with the IAEA, was complying with the inspection
requirements of that agency, and was widely known in the interna
tional community. Conversely, Iraq's post-1981 program was secre
tive and included several underground facilities. Even with the
vaunted intelligence capabilities of the United States, most of those
facilities were not discovered until after Operation Desert Storm.
Other nations, including North Korea, have apparently adopted the
Iraqi technique of hiding some of their installations underground. 8
Concealment techniques mean that nations conducting preemp
tive strikes could never be certain that they had discovered, much
less destroyed, all of the facilities-unless they were prepared to
invade and occupy the offending country. If some facilities escaped
destruction, the nuclear-weapons program of the target country
could still go forward (probably with redoubled efforts at secrecy).
Moreover, the nation that had been attacked would have every
incentive to seek revenge. Bombing North Korea's nuclear facilities,
for example, could easily trigger a general war on that heavily
armed peninsula. If Pyongyang decided to respond to a preemptive
strike by launching an attack across the demilitarized zone, the
nearly 40,000 U. S. troops deployed in the ROK-most of them
directly astride the invasion routes from the DMZ to Seoul-would
be immediately involved. It would be a high-stakes gamble, at best,
to assume that Pyongyang would accept the humiliation of having
8
0ne expert also notes that unlike the first generation of nuclear-armed states,
the newer aspirants are not likely to announce their intentions through the test
of an explosive device. Threshold states have apparently concluded that quality
assurance can be obtained without testing. That change greatly complicates the
process of discovering whether a state has a clandestine program. Jed L. Snyder,
"Weapons Proliferation and the New Security Agenda," in On Not Confusing Our
selves: Essays on National Security in Honor of Albert and Roberta Wohlstetter, ed. Andrew
Marshall, J. J. Martin, and Henry S. Rowen (Boulder, Colo.: Westview, 1991),
pp. 272-74.
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Nuclear Prolifertion
its nuclear installations destroyed without making a military
response.
Even if a target regime did not resort to overt military action, there
would always be the possibility of a terrorist reprisal. Proponents of
the April 1986 air attacks on Libya believed that those attacks had
intimidated Qadaffi and quelled Libyan-sponsored terrorism. U. S.
officials persisted i n that illusion until the autumn of 1991 when
evidence pointed to the involvement of two high-ranking officials
of Libya's intelligence service in the bombing of Pan American
flight 103 over Lockerbie, Scotland, in December 1988. If that evi
dence proves to be accurate, Libya exacted a fierce revenge for the
1986 attacks, even though it waited nearly three years to do so.
Finally, there are significant political problems associated with
a policy of coercive nonproliferation. The possibilities for double
standards and hidden agendas are virtually unlimited. If the UN
Security Council arrogates the right to judge proliferation matters,
the fact that the five permanent members are also the five openly
declared nuclear-weapons states is not going to go unnoticed by
nations seeking to acquire such weapons. From their perspective
it will be the verdict of a kangaroo court, however much the council
may invoke noble-sounding principles. And the United States, as
the leader of an international program of coercive nonproliferation,
will be the principal target of their wrath, even though those nations
might otherwise have no reason to regard America as an enemy.
A strategy of coercive nonproliferation might succeed in prevent
ing some proliferation, but it is unlikely to halt the trend, and it
would create a host of new risks and problems for the United States.
Moreover, proponents of that strategy show no signs of regarding
it as a replacement for America's Cold War policy of extended
deterrence. The United States would still have the unenviable task
of protecting nonnuclear allies from such declared nuclear powers
as China, existing undeclared nuclear-weapons states, and any new
nuclear powers that might succeed in evading the strictures of a
coercive nonproliferation system.
Adjusting to Proliferation
Instead of clinging to a futile status quo plus policy or adopting
the excessively dangerous coercive nonproliferation approach, the
United States should adopt a strategy that adjusts to the reality of
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MARKET LIBERALISM
nuclear-weapons proliferation and devise ways to insulate America
from its most harmful consequences. The emergence of a multipolar
nuclear-weapons environment has several implications for U. S.
policy. First, it underscores the need to maintain a credible deterrent
despite the demise of the Soviet adversary. That is not to say that
the United States cannot make sizable reductions in its strategic
arsenal. The agreement reached at the June 1992 U. S. -Russian sum
mit meeting to reduce each country's arsenal to no more than
3, 500 bombs and warheads within 11 years is a promising start.
Washington should go further and agree to Russian president Boris
Yeltsin's original proposal for a ceiling of 2,000 weapons. Moreover,
Washington can contribute to the easing of global nuclear tensions
by unilaterally suspending U. S. nuclear tests for a five-year period
and seeking an international agreement sharply limiting under
ground tests thereafter.
9
Such an agreement would be an appro
priate companion to the 1963 treaty that outlawed atmospheric
nuclear tests.
Nevertheless, it is essential for the United States to keep an
arsenal that is sufficiently large to deter an attack on American
territory by all except the most irrational regimes. Beyond a certain
point, fewer is not necessarily better when it comes to nuclear
weapons. An excessively small U. S. arsenal might tempt an aggres
sive state to assume that it could "take out" that arsenal with a
sufficiently coordinated attack. Even if that assumption proved
wrong-as it probably would-that would be small comfort to
Americans after a nuclear exchange. There is also a more subtle
danger created by excessive reductions. As the U. S. arsenal became
smaller, the relative strength of even minor nuclear powers would
become greater. That would certainly be the case if the United
States cut its arsenal to 1, 000 weapons-as suggested by former
secretary of defense Robert McNamara and others-much less to
9Washington should not, however, sign a treaty that would forever prohibit
underground nuclear tests. Changes in technology can affect nuclear weaponry as
they can other components of the military, and the United States must retain the
ability to keep abreast of those changes. A total ban on nuclear testing could, in
time, render the U. S. arsenal obsolete. Recent congressional legislation that would
restrict underground tests until 1997 and then impose a permanent ban reverses
the order of the steps the United States should take.
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Nuclear Proliferation
even lower levels. lO Creating even the impression of strategic parity
between the United States and emerging nuclear powers would
heighten the potential for miscalculation on their part.
A would-be aggressor must have no doubt that even the most
well coordinated attack would still leave enough U. S. weapons to
produce a devastating counterstroke. Given the continued exis
tence of other significant nuclear powers, an arsenal of fewer than
2, 000 bombs and warheads might undermine the credibility of the
U. S. deterrent.
Maintaining an adequate deterrent would materially reduce the
probability of a premeditated attack on U. S. territory, but three
possible sources of danger remain. One is an accidental launch of
nuclear weapons, a risk that is likely to mount with an increase in
the number of nuclear-weapons states. Many of the new nuclear
powers will have neither the financial resources nor the technologi
cal sophistication to establish the kinds of elaborate command and
control systems that were developed by the United States and the
Soviet Union.
A second source is the threat posed by the occasional undeterra
ble leader or regime-the so-called crazy state phenomenon.
Although there may be a tendency on the part .of observers in
Western democratic nations to exaggerate the irrationality of mercu
rial dictators, the crazy state scenario cannot be ignored-especially
in a multipolar nuclear environment.
The third source of danger is the possibility that a conventional
conflict might spiral out of control and, through a series of miscalcu
lations, culminate in a nuclear exchange. The emergence of a multi
polar international system increases the probability of disorders
and conflicts, and given the proliferation of nuclear weapons,
increases the odds that one might breach the nuclear threshold.
Although the United States can take steps to reduce the likelihood
of becoming a party to such conflicts, it cannot guarantee that it
will never be a target of a belligerent.
For all those reasons, it is essential that the United States augment
a credible deterrent with effective air and missile defenses-the
second adjustment that U. S. policy should make to the reality of
IOCarl Kaysen, Robert S. McNamara, and George W. Rathjens, "Nuclear Weapons
after the Cold War," Foreign Afairs 70 (Fall 1991): 95-1 10.
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MARKET LIBERALISM
nuclear-weapons proliferation. An antiballistic missile (ABM) sys
tem does not require implementing President Ronald Reagan's
ambitious Strategic Defense Initiative, since repelling an onslaught
by the entire Soviet missile feet is now an extremely improbable
mission. A "thin layer" ABM system, however, could offer crucial
protection in the case of an accidental launch of a few dozen mis
siles. The same would be true of a deliberate attack by a new nuclear
power that had a limited arsenal.
Many of the nations that are seeking to acquire nuclear weapons
also have serious programs to build ballistic missiles. Because no
Third World state is likely to have intercontinental ballistic missiles
(ICBMs) by the end of this decade-the goal of most existing pro
grams appears to be confined to the development of short- or
medium-range missiles capable of reaching regional adversaries
opponents of ABMs contend that the United States should delay
efforts to build a defensive shield until a credible ICBM threat to
U. S. territory emerges.
l
l
Their conclusion is myopic. First of all, it ignores the problem of
an accidental launch of existing CIS missiles. Moreover, it is not
all that large a technological leap from developing shorter range
missiles to having an ICBM capability. Although many of the new
nuclear-weapons states may not feel the acquisition of an ICBM
fleet is worth the expense, others may conclude that they must be
able to threaten the U. S. homeland to prevent Washington fror
interfering with their regional agendas. Moreover, missile defenses
cannot be built overnight. Even the single ABM installation in North
Dakota, authorized by Congress in 1991, will not be operational
until 1997 at the earliest. Building a nationwide system would take
considerably longer. We cannot wait until hostile powers have fully
operational ICBM fleets to build adequate defenses.
The other principal objection raised by critics-that ABM systems
offer no protection against alternative delivery methods that enemy
governments or terrorist movements might use-is also unconvinc
ing. True, hostile forces might find other means of delivering
"For examples of that reasoning, see David C. Morrison, "Where's the Threat?"
National Journal, October 26, 1991, p. 2629; "A Meaningful SOl Mission," editorial,
Boston Globe, November 2, 1991, p. 18; and Matt Hansen, "Sounding Taps for Star
Wars and the Stealth Bomber," Defense Monitor 20, no. 5 (Washington: Center for
Defense Information, 1991).
270
Nuclear Proliferation
nuclear weapons-using small aircraft or smuggling in "satchel
bombs," for example. But the fact that a defense system would not
neutralize all threats does not mean that we should refuse to use
it against threats that it can thwart. Moreover, there is a crucial
difference in the magnitude of the potential damage from various
delivery systems. It is unlikely, for example, that a smuggling oper
ation could successfully deploy more than a few small devices in
a handful of cities. Although the detonation of such weapons would
undoubtedly cause extensive damage and loss of life, America could
probably recover. (The Soviet Union was able to survive the loss
of more than 10 percent of its population and the destruction of
many of its major cities in World War II . ) Conversely, the detonation
of numerous larger, more destructive missile warheads could dev
astate American civilization beyond recovery.
Even an imperfect shield would protect the vast majority of Amer
ican population centers from that kind of massive damage. As a
collateral benefit, it would reduce the likelihood of nuclear black
mail. In a world with nuclear-weapons proliferation, basic prudence
dictates that U. S. leaders not leave the American people defenseless
against a missile attack.
A third policy adjustment to nuclear proliferation should be the
exercise of far greater caution about involving the United States in
disputes that are not highly relevant to America's own vital security
interests. The most important step would be to abandon the doc
trine of extended deterrence. During the Cold War a plausible case
could be made that the United States had to assume the risks
entailed in extended deterrence to prevent Moscow from achieving
global hegemony through nuclear blackmail or outright aggression,
although some perceptive critics argued that the level of risk run
by the United States was excessive even then.
Without the threat posed by a would-be hegemonic challenger,
assuming the risk is even more unwarranted. Not only might it
prove considerably more difficult to deter an assortment of small
nuclear-weapons states than it did to deter the Soviet Union, but
even the theoretical benefits to the United States are considerably
more modest. It is difficult to imagine what interest could be impor
tant enough to justify America's defending South Korea from a
nuclearized North Korea. The stakes involved are hardly of the
same magnitude as those that existed during the Cold War. In
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MARKET LIBERLISM
a post-Cold War international system, extended deterrence is a
superpower status symbol that the United States can no longer
afford.
Beyond m
a
king it necessary for the United States to rescind the
promises of extended deterrence to major allies, nuclear prolifera
tion makes it imperative that Washington exercise greater caution
about meddling in regional quarrels. The threshold for concluding
that a vital U. S. security interest is involved in such disputes should
be extremely high. The only thing worse than needlessly becoming
entangled in a confict between belligerents armed with conven
tional weapons would be to do so when one or more of the parties
are armed with nuclear weapons. That level of risk should never
be undertaken unless a vital American interest is in imminent
jeopardy.
The final needed adjustment is to change the focus of Washing
ton's nonproliferation policy. U. S. policymakers must rid them
selves of the attitude that all forms of proliferation are equally bad.
It ought to make a substantial difference to Americans whether
nuclear weapons are acquired by a stable, democratic state with
which the United States has had a lengthy record of good relations
or by an unstable or brutal anti-American dictatorship. Yet the
provisions of the NPT permit no such distinction. Moreover, U. S.
proponents of the NPT have been as determined t o prevent such
stable democratic nations as Japan and Germany from developing
nuclear weapons as they have Third World states-indeed, they
frequently have seemed more determined.
Those priorities must change. It is not that Washington should
encourage its major West European and East Asian allies to develop
their own arsenals. Encouragement would probably be superfluous
in any case. A decision by the United States to rescind the doctrine
of extended deterrence would impel each of those nations to reas
sess its policy toward nuclear weapons in light of its own circum
stances and security requirements. Some might decide to take the
risk of remaining nonnuclear in an increasingly nuclear world or
conclude that they can neutralize the danger through sufficiently
sophisticated conventional weapons. (The U. S. performance in
Operation Desert Storm demonstrated that a considerable amount
of damage can be inflicted on the infrastructure of an adversary
with such weapons. ) Most beneficiaries of the U. S. nuclear umbrella
272
Nuclear Proliferation
throughout the Cold War, however, would probably conclude that
they now need independent deterrents. What is required from
Washington is not overt encouragement but merely acceptance of
that change. U. S. leaders need not be accomplices in facilitating
the acquisition of nuclear arsenals by other Western democratic
states, but they must abandon the policy of obstructionism.
To do so, the United States will need to move beyond the "one
size fts all" philosophy embodied in the NPT. Indeed, Washington
should decline to support an extension of the NPT when it comes
up for renewal in 1995. To the extent that Washington wishes to
continue pursuing a nonproliferation strategy, it should concen
trate on making it difficult for aggressive or unstable regimes to
acquire the technology needed to become nuclear powers. And
U. S. policymakers must adopt a realistic attitude toward the limita
tions of even that more tightly focused nonproliferation policy. At
best, U. S. actions will only delay, not prevent, such states from
joining the nuclear-weapons club.
But delay can provide some important benefits. It may give the
United States time to develop adequate strategic defenses and other
Western nations time to build their own deterrents or strategic
defense systems, or both. A delay of only a few years may signifi
cantly reduce the likelihood that an aggressive power with a new
nuclear-weapons capability will have a regional monopoly and be
able to blackmail nonnuclear states. In some cases, the knowledge
that the achievement of regional nuclear hegemony is impossible
may even discourage a would-be aggressor from making the effort.
At the very least, it could cause such a power to configure its
new arsenal for deterrence rather than for intimidating neighboring
countries for political gain.
There are other steps the United States can take to limit some of
the harmful effects of proliferation. One of the most worrisome
prospects is that many of the new nuclear states will lack the finan
cial resources or the technical expertise to establish reliable com
mand and control systems or to guard their arsenals from theft or
terrorism. Inadequate safeguards greatly increase the danger of an
accidental or unauthorized launch. Beyond that problem is the
more subtle danger that some of those nuclear powers may fail to
develop coherent strategic doctrines that would let adversaries
know the circumstances under which the aggrieved party might
use nuclear weapons.
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MARKET LIBERALISM
Washington can help minimize such problems by disseminating
command and control technology and assisting in the creation of
crisis management hot lines and other confidence-building mea
sures among emerging nuclear powers. The United States can also
encourage potential adversaries to engage in strategic dialogues
to delineate the kinds of provocations that might cause them to
contemplate using nuclear weapons and outline the doctrines that
would govern their use. Such a dialogue helped stabilize the dan
gerous superpower rivalry and might have a similar effect on
regional confrontations. At the very least, it would reduce the
chances of a nuclear conflict erupting because of miscalculation or
misunderstanding.
A policy of adjusting to proliferation is not a panacea. It is,
however, superior to the status quo plus policy-an ostrichlike
response based on the assumptions that proliferation can be pre
vented indefinitely and that all forms of proliferation are equally
undesirable from the standpoint of U. S. security interests. It is also
superior to the dangerous and provocative alternative of coercive
nonproliferation. The United States cannot prevent the spread of
nuclear weapons, but a strategy of adjustment offers the most
prudent method of minimizing its negative consequences for the
American people.
The new administration's action plan on nuclear-weapons policy
should include the following steps.
Issue a formal notice that the United States will no longer partici
pate in the Nuclear Nonproliferation Treaty when it comes up
for extension in 1995.
Accept Boris Yeltsin's original proposal to reduce the U. S. and
Russian strategic arsenals to 2, 000 weapons each.
Accelerate the ABM program with the goal of deploying a nation
wide system within 10 years.
Suspend all U. S. nuclear tests for five years and commence nego
tiations for an international treaty to strictly limit underground
nuclear tests as a supplement to the 1963 atmospheric test ban
treaty.
Rescind the doctrine of extended deterrence and affirm that the
U. S. nuclear arsenal will exist solely to deter attacks on vital
American security interests.
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Nuclear Proliferation
Indicate to major democratic capitalist nations in Western Europe
and East Asia that the United States will no longer seek to block
them from creating independent strategic deterrents .
Seek ways to help emerging nuclear powers create reliable control
systems to prevent accidental or unauthorized launches and
assist those countries to articulate defensive nuclear doctrines.
275
1b. A Post-Cold War Military Budget
Jefrey R. Gerlach
The end of the Cold War offers the United States a rare opportu
nity to fundamentally recast its national security policy. The col
lapse of the Soviet Union and the utter failure of communism as a
viable political system have drastically altered America' s place in
the world. With no reason to "pay any price, bear any burden" to
oppose the Soviets and their surrogates, the United States can
return to the foreign policy posture designed by the Founding
Fathers that guided the nation for most of its history. Such a policy
would forgo aggressive pursuit of utopian goals, such as global
stability or universal democracy, and focus instead on the defense
of American territory, sovereignty, and liberty. U. S. military forces
would be used solely to defend America against threats to her vital
interests. A restrained foreign policy, based on the principle of
avoiding unnecessary foreign entanglements, would allow a dra
matic paring of America's defense expenditures. The United States
would maintain extensive economic, social, cultural, and diplo
matic links with other nations, but military relations would be
substantially curtailed. The resulting savings could be returned to
the American people.
The Base Force Concept
The Pentagon responded to the disintegration of the communist
threat by developing plans for a Base Force designed to meet Ameri
ca's defense needs. From its post-Vietnam peak of 2. 2 million in
1987, the active duty force would fall to 1. 6 million by 1995, a
reduction of about 25 percent. Reserve and civilian personnel would
be reduced by about 20 percent. A number of major weapons pro
grams-including the B-2 bomber, the Minuteman III interconti
nental ballistic missile, the Sea wolf submarine, the Comanche heli
copter, and the air defense anti-tank system-would be scaled
back or eliminated. The new security structure, though hailed as a
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MARKET LIBERALISM
dramatic reduction in U. S. military spending, would only modestly
reduce expenditures for the next several years.
The proposed fiscal year 1993 defense budget called for spending
$281 billion. Under that scenario, military spending would remain
roughly constant through 1995, then rise to $290. 6 billion in 1997,
the final year considered. The House and Senate agreed on an
FY93 military budget of $274. 3 billion, some $7 billion less than the
Department of Defense requested, and made a number of changes.
Congress reduced funding for the Strategic Defense Initiative, oper
ations and maintenance programs, and sealift capabilities and
ordered changes in inventory management and overseas basing
costs. Those changes are expected to save billions. Congress also
funded a number of programs that were not in the DOD's original
budget, including the V-22 tiltrotor aircraft, the Comanche helicop
ter, and the LHD amphibious assault ship, and increased funding
for a number of defense conversion projects.
Though it lowered overall defense spending marginally, Con
gress basically approved the Pentagon's plan. The DOD is reducing
military spending in real terms by about 4 percent per year through
1997 instead of the 3 percent it originally projected after the fall of
the Berlin Wall in 1989. The revised budget figures represent a
cumulative real decline of 35 percent between 1985 and 1997. Penta
gon statistics show that defense spending as a share of the nation's
gross national product has also declined. That figure, currently
around 5 percent, is scheduled to fall to 3. 5 percent in 1997.
Despite attempts by the Pentagon to characterize the cuts as
substantial, they are actually quite modest. The DOD does not
present what is perhaps the most useful indicator of the size of the
current military budget. According to the Congressional Budget
Office, measured in real terms, defense spending is roughly the
same now as it was in the early 1960s, at the height of the Cold
War. If approximately $280 billion (in constant dollars) was suffi
cient when the United States faced an adversary of great size and
strength, it surely exceeds U. S. security needs now that the Soviet
Union has collapsed.
Defense spending as a percentage of GNP reveals only the burden
placed on the U. S. economy by military spending; it tells nothing
about the amount of money that should be spent on defense. Proper
levels of spending can be determined only by examining America's
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Militar Budget
security interests, evaluating the potential threats to those interests,
and striking a balance between the nation's resources and commit
ments. Under some conditions, the United States might need to
devote a large percentage of its GNP to ensuring its security. Under
other conditions, a small percentage would suffice. Thus, it is irrele
vant that military spending as a percentage of GNP is falling. A
military budget must be developed on the basis of the nation's
security needs, not the size of its economy.
Furthermore, the decline of military spending as a percentage of
GNP reflects primarily the tremendous growth of the American
economy since 1960. The GNP of the United States in 1960 was
$1,985. 1 billion (1987 dollars) compared to a 1991 GNP of $4,836. 4
billion. Given that economic expansion, it is not at all surprising
that military spending has fallen as a percentage of GNP. Indeed,
it would have been astonishing if such a decline had not occurred
despite the spending appetites of Pentagon officials.
Another faw in the DOD statistics is that the analysis on which
they are based covers a time period that was carefully chosen by
the Pentagon. To demonstrate that the defense budget is indeed
falling, the DOD uses either FY85 or FY87 as the base year for most
of the raw numbers. That is inherently misleading since the early
and middle 1980s witnessed a tremendous increase in military
spending. Spending for defense and international programs rose
from $146. 7 billion in 1980 to $293. 6 billion in 1987 (current dollars).
In real terms, the Reagan administration's defense budget for FY87
represented more than the United States had previously spent in
any one year since the end of World War II. As military spending
moves to more "normal" levels, the appearance is created that
drastic cuts are being made. In essence, however, the United States
is simply returning to business-as-usual Cold War figures.
The statistics are skewed at the other end of the time period as
well . DOD projections end in 1997, when the defense budget would
be $274. 6 billion (1992 dollars), but the Congressional Budget Office
has released a study that examines probable military spending
through the year 2010, and its analysis shows a very different
outcome. The CBO estimates the amount of money that will be
needed to maintain the Base Force concept, which will serve as
the guide for future defense spending. It assumes that military
manpower will remain roughly constant and that weapons systems
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MARKET LIBERALISM
will be maintained and modernized. The study concludes that "sub
stantial increases in funding could be required in the years beyond
1997 to maintain and modernize the Base Force under the adminis
tration's plans. ") According to the CBO, by the middle of the next
decade, annual military spending ( 1992 dollars) will exceed 1997
levels by $20 billion to $65 billion.
The main reason for the increases will be the need to replace
aging equipment. Much of the savings in the 1 993-97 period is
derived by postponing modernization and replacement. During the
next decade, the CBO argues quite convincingly, both moderniza
tion and replacement must occur. The $20 billion estimate assumes
that acquisition costs will be similar to those of the recent past.
The $65 billion estimate, on the other hand, assumes that costs of
weapons research and development will rise. The CBO suggests
that the latter is the more likely because increasingly sophisticated
weapons tend to be increasingly expensive. According to the Ne
York Times, Pentagon officials realize that "projected military spend
ing simply will not cover the costs required to equip, train and
maintain the troops and accompanying ships, aircraft and ground
units called for in the long-range budgets.
,,
2
Thus, even the meager peace dividend outlined in current budg
etary projections is likely to be very short-lived. If the Base Force
concept is maintained, costs will rise significantly after 1997. The
result is likely to be military budgets similar to those of the 1980s
during a period in which the United States will have no serious
military competitors.
National Military Strategy
Though pressure from various interest groups can often distort
defense spending, the overall budget reflects the nation's percep
tion of its security needs. As defense analyst Earl C. Ravenal points
out, "A defense budget represents a view of the world and of the
place and role of a nation in that world. "3 Thus, it is important to
'''Fiscal Implications of the Administration's Proposed Base Force," Congres
sional Budget Office Staff Memorandum, December 1991. p. I I .
2Eric Schmitt, "Military Planning Deep Budget Cuts," Ne York Times, August
30, 1992, p. AI.
3Earl C. Ravenal, Designing Defense for a Ne World Order: The Military Budget in
I JJZ and Beyond (Washington: Cato Institute, 1991), p. 7.
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Militar Budget
examine the assumptions underlying U. S. military expenditures.
Washington's military strategy merely replaces the global focus of
the Cold War with a new, but equally expansive, regional emphasis
that assumes the United States must be prepared to counter a
variety of local threats instead of a worldwide communist enemy.
According to the Joint Chiefs of Staff's "National Military Strategy"
(1992), "The United States must maintain the strength necessary
to influence world events, deter would-be aggressors, guarantee
free access to global markets, and encourage continued democratic
and economic progress in an atmosphere of enhanced stability. "4
Maintaining stability is the overwhelming theme of the new doc
trine. "The threat is instability and being unprepared to handle a
crisis or war that no one predicted or expected. "s
Two of the components outlined in the "National Military Strat
egy" emphasize the open-ended nature of proposed U. S. missions
in the post-Cold War era. Forward Presence refers to the need to
continue deploying U. S. troops in key regions of the world, allow
ing the United States to respond to threats to stability from any
area of the globe. Crisis Response is an even broader mission that
suggests that the United States must be prepared to respond to
any contingency anywhere in the world. In addition, the DOD
recognizes that aggression might not be limited to just one area of
the planet; thus, the United States must have adequate forces to
counter a number of potential adversaries simultaneously.
Crisis Response and Forward Presence highlight the goal of main
taining stability in a dangerous world. There are, however, a num
ber of fundamental problems with the new regional outlook. One
of the more significant flaws is the loose definition of areas that
are "vital" U. S. interests. The regional strategy appears destined
to lead the United States into conflicts that clearly involve no more
than peripheral U. S. interests. The DOD is generally quite vague
about areas of possible conflict. In classified documents leaked to
the media, however, Pentagon planners detailed seven scenarios
for regional conflicts. 6 Perhaps the most dangerous involved a
4Joint Chiefs of Staff, "National Military Strategy, " 1992, p. 2.
sIbid. , p. 4.
6Patrick E. Tyler, "Seven Hypothetical Conflicts Foreseen by the Pentagon," New
York Times, February 1 7, 1992, p. AS.
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MARKET LIBERLISM
resurgent Russia's invading Lithuania and being repulsed by a U. S.
led NATO counterattack. The clear implication i s that Lithuania is
an area of vital interest to the United States. That assumption is
extremely dubious when one considers that Lithuania was totally
dominated by the Soviet Union for 50 years-a tragic situation for
the Lithuanian people, but one that did not seem to impair vital
U. S. interests. Although it is certainly preferable that Lithuania be
a free and independent state, that objective is not central to the
security of the United States. Lithuanian independence is not worth
the risk of a major conflict between states heavily armed with
nuclear weapons. Taking such a risk would be both illogical and
dangerous.
"Defense Planning Guidance for the Fiscal Years 19941999,"
another document leaked to the media in the spring of 1992, further
clarifies DOD intentions. That study asserts that the U. S. role in
the new world order should be to ensure that no rival superpower
emerges. The key to achieving that goal is to "sufficiently account
for the interests of the advanced industrial nations to discourage
them from challenging our leadership or seeking to overturn the
established political and economic order. The two main objectives
inherent in the plan are to prevent the emergence of a new global
rival and to address "sources of regional conflict and instability in
such a way as to promote increasing respect for international law,
limit international violence, and encourage the spread of democratic
forms of government and open economic systems. "
The first objective-preventing the emergence of a global rival
is easily achieved for the near future since the powers that have
the industrial base to challenge the United States militarily are in
disarray or uninterested in territorial expansion. Any resurgent
threat would take years to develop, thus allowing America time to
react. The first objective clearly does not require nearly $300 billion
a year in military expenditures. Achieving the second objective
preventing regional conficts-requires much more effort.
Although the planners explicitly state that the United States will
not be the "world's policeman, " the document outlines precisely
that role. The elaborate system of alliances and military guarantees
7
Patrick E. Tyler, L. b. Strategy Plan Calls for Insuring No Rivals Develop," Ne
York Times, March 8, 1992, p. 1 .
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Militar Budget
built up over the last four decades to combat communism sets the
stage for U. S. involvement in virtually every area of the world.
Indeed, the DOD argues that threats flare likely to arise in regions
critical to the security of the United States and its allies, including
Europe, East Asia, the Middle East and Southwest Asia, and the
territory of the former Soviet Union. We also have important inter
ests at stake in Latin America, Oceania, and Sub-Saharan Africa. "s
In other words, potential challenges await the U. S. military on
every continent with the exception of Antarctica.
The central problem with linking defense spending to a quest to
deter instability is that there is almost no limit to the number of
potentially destabilizing situations in which the United States might
feel obligated to intervene. During the Cold War, the intelligence
agencies provided estimates (of questionable accuracy) of the
strength of the Soviet Union and its client states. Those estimates,
however flawed, allowed military planners to come up with specific
requirements for countering the Soviet threat. Under the regional
strategy, the only limit to sources of potential instability is the
imagination of Pentagon officials.
By making stability a major goal of u. s. security policy, U. S.
officials seem to be suggesting that change i n the international
arena may occur only on American terms. If change does not occur
on U. S. terms, Washington will presumably seek to prevent or
reverse particular developments. Throughout history, however,
the international system has been turbulent, and there is no reason
to believe the system will be any different in the future. Turbulence
tends to increase in the years following the collapse of empires
(e. g. , the Habsburg, Ottoman, British and French, and now the
Soviet). U. S. foreign policy must have the flexibility to accommo
date various transformations in international politics. A policy
based on an obsession with stability is particularly ironic in an era
of transition. In the new international system, it will be impossible
to maintain order throughout all regions. Furthermore, instability
already reigns in many areas of the globe where ethnic conflicts,
border disputes, insurgencies, terrorist threats, and other poten
tially destabilizing forces persist. The U. S. commitment to stability
S"Excerpts from Pentagon's Plan: Prevent the Emergence of a New Rval," Ne
York Times, March 8, 1992, p. A14.
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MARKET LIBERALISM
suggests that the nation must be prepared to intervene in many
instances to maintain the status quo even though change of one
kind or another is inevitable. That is a dangerously short-sighted
policy.
The temptation to intervene in areas of crisis is particularly evi
dent in recent media debates. Over the past year, editorial writers
have urged the United States to intervene with force in such dispa
rate regions as Yugoslavia, Somalia, Haiti, and parts of the former
Soviet Union. Imposing just solutions to those crises would be an
enormous task, but it is the tip of the iceberg of the potential for
regional violence in the post-Cold War era. Fighting is currently
occurring in Armenia and Azerbaijan, Georgia, Afghanistan, Tajiki
stan, Turkey, Indonesia, India, Liberia, Sudan, Peru, and a host
of other places; that list does not include areas, in virtually every
corner of the globe, where violence is apt to break out. To achieve
stability throughout the world, the United States must be prepared
to intervene repeatedly to halt conflict and maintain the status quo.
That is a task that goes well beyond legitimate American security
requirements.
Jobs, Jobs, Jobs
Pork-barrel politics has always played a role in determining mili
tary expenditures. During the Cold War, the presence of a formida
ble enemy provided at least some rationale for continuing programs
of dubious value. However, in an era when significant threats to
the United States have virtually disappeared, it is intolerable to
continue to justify defense spending on the basis of its alleged
economic benefits to particular groups or regions. In 1992 the
November elections and a continuing recession, amid general
doubts about America's economic competitiveness, made jobs a
critical political issue. Paralyzed by fears that reductions in military
expenditures would raise unemployment, politicians of all political
stripes rallied to support defense spending. As a result, significant
national security issues were decided on the basis of economic
concerns, not military considerations.
The Pentagon's decision to cancel the $2 billion Seawolf subma
rine, a weapon designed to counter the now-defunct Soviet threat,
is an excellent example. Sen. Christopher J. Dodd and Rep. Sam
Gejdenson, both Democrats from Connecticut and opponents of
284
Militar Budget
the Reagan defense build-up, fought desperately to override the
administration's decision. Both argued that the submarine is vital
to America's defense needs. A more plausible explanation of their
support for the Seawolf was their desire to save thousands of jobs
in Groton, Connecticut. Gejdenson attempted to justify his position
in a New York Times article. "There are better things to-choose to
build (than the Seawolf), but the worst thing to do is to choose not
to build anything.
,,
9 It does not take a Ph. D. in economics to realize
that building obsolete submarines is not the most efficient use of
scarce American resources.
Connecticut's other senator, Joseph Lieberman, also a Democrat,
joined Dodd in proposing a loan guarantee program for countries
that want to buy directly from U. S. weapons makers. Thus, Ameri
cans could subsidize such products twice, in the production phase
and again in the sales phase. Connecticut, of course, is not the
only state whose legislators are more concerned about local jobs
than national defense requirements. Numerous commentators
have noted that the best way to convert congressional doves to
hawks is to try to cancel defense contracts in their districts. Rep.
Julian Dixon of California, a Democrat who has in the past spon
sored plans to reduce defense spending, provides a succinct expla
nation of the politics of defense pork. "The bottom line is, what is
it going to do to my community' s economy?"lO Contrast that with
the view that the nation's defense spending should be based on a
sober calculation of its security needs.
Even members of Congress who have previously taken a strong
stand against using the defense budget for programs not related
to national security have been guilty. Last year, for example, Sen.
John Warner (R-Va. ) stated, "At a time when declining defense
budgets are forcing the administration and the Congress to make
diffiqIlt choices . . . I find it completely unacceptable that defense
dollars are diverted to projects that have not been reviewed or
requested by (the Defense Department) . "ll Yet in last-minute nego
tiations, against administration wishes and without debate, he
9Clifford Krauss, "In Battle of Budget, Democrats Defend Military Hardware,"
Ne York Times, March 17, 1992.
'Ojackie Calmes, "Guns for Butter; Ardor to Trim Defense Hits Political Obstacle:
The Fear of job Losses," Ne York Times, May 7, 1992, p. AI.
"john Lancaster, "Senators Take Care of Own i n Pentagon's Budget Bill," Washing
ton Post, September 23, 1992, p. AI.
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MARKET LIBERALISM
added $60 million to the defense budget for night-vision goggles,
manufactured in his home state, for the National Guard. In explain
ing his actions, Warner commented: "Look, any lawmaker thinks
in terms of his state and his industrial base. Obviously that influ
enced my thinking.
r/1Z
The blame for such indiscriminate spending should not be placed
solely on Congress, however. Despite Secretary of Defense Richard
Cheney's firm pledge that the defense budget would not be a jobs
program, the executive branch has been guilty of using defense
funds to shore up political support. During the election campaign,
the Bush administration announced a $250 million plan to upgrade
the M-l tank, even though White House officials had previously
argued that the end of the Cold War made the improved version
unnecessary. The V-22 Osprey tiltrotor aircraft, another weapon
that the Pentagon had determined was unnecessary, was also saved
by the president. While visiting hurricane-ravaged Florida, Bush
promised to rebuild Homestead Air Force base, despite the facts
that it had been a candidate for closure and that many other bases
must be closed. On a trip to Fort Worth, Texas, where the F-16 is
made by General Dynamics, he approved the sale of 150 aircraft
(worth $4 billion) to Taiwan. He followed that with an agreement
to sell Saudi Arabia 72 F-15s ($5 billion). Bush also contended that
the modest cuts Bill Clinton supported would cost a million defense
related jobs. The writers of campaign rhetoric neglected to consider
the jobs that would be created by channeling resources to more
efficient sectors of the economy. Such moves were clearly divorced
from national security considerations and reflected a desire to avoid
layoffs during an election campaign.
Clinton, despite his pledge to trim defense by $60 billion (over
a five-year period) more than the Bush administration would, gave
few indications that he was any more immune to domestic consider
ations than Bush. Campaigning in Connecticut during the Demo
cratic primary, for example, Clinton made his support of the Sea
wolf submarine a major issue. Perhaps even more indicative, he
suggested maintaining larger National Guard and Reserve forces
than did President Bush. The Guard and Reserve are powerful
lobbies that have resisted budget cuts. They provide jobs in local
12
Ibid.
286
Militar Budget
communities and tremendous support to politicians who earn their
favor.
If anything, Clinton appeared to favor expanding the role of the
military well beyond that of national security. In a major foreign
policy address, he described the Pentagon as America's best youth
training program, our most potent research center and the most
fully integrated institution in American life. It's time to put those
assets to work at home . . . . There ought to be some other work
for military forces and the National Guard in solving the problems
of infrastructure, education, and rural health-offering the possibil
ity to our military personnel to serve as role models here at home,
all the while maintaining their consistent obligation to fulfill their
primary military mission. "13 Such plans reflect an extremely broad
definition of the nation's security.
The temptation to develop new roles for the military must be
resisted. As threats recede, spending should decline correspond
ingly. National security, not social welfare concerns, should dictate
the level of defense spending. Health, education, and America's
infrastructure are all legitimate issues, but they should not be within
the purview of the Pentagon. The best prospect for military person
nel and defense workers displaced by budget cuts is a healthy and
growing economy that will produce jobs. After World War II, the
military budget was slashed and defense and defense-related
employment fell by more than 10 million in just two years. Yet by
1948, in a labor market half the size of today's, most of those
people had been absorbed into the economy with little government
assistance. That the period after the war was one of impressive
growth in the U. S. economy certainly provides a lesson that policy
makers in Washington should remember.
The short-term problem of dislocation of workers is best met by
offering incentives for voluntary separation, much as the Pentagon
has already done. Voluntary separation bonuses allow an individ
ual to determine how best to plan for the future, such as moving
to another region to seek work, returning to school for further
education or training, or opening a business. Bonuses do not con
tinue open-ended funding of programs that are unnecessary. The
13BiII Clinton, "Remarks of Governor Bill Clinton," to the Los Angeles World
Affairs Council, August 13, 1992 (transcript).
287
MARKET LIBERALISM
worst solution is to continue employing people in useless indus
tries, thus draining the economy of funds that could be spent on
productive enterprises. Another alternative proposed by both par
ties, government-funded defense conversion programs, has proven
noticeably unsuccessful in the past. Defense industries are designed
to produce military products, and their track record in converting
to civilian products is dismal.
A Real Alternative
Though pork-barrel politics distorts defense spending, the under
lying reason for profligate U. S military spending is a national secu
rity strategy that commits the United States to maintaining stability
throughout the world. Once that premise is accepted, large military
expenditures must inevitably follow. One might be able to pare
defense spending by eliminating inefficiencies and waste, but the
current national security strategy requires a large, far-flung military.
Most alternative proposals put forth by political leaders, think
tanks, academics, and others decrease projected budgets somewhat
more than the DOD intends but accept the basic strategy outlined
by the Pentagon.
In some respects that approach can be more dangerous than
the current strategy. Ravenal, for example, has stressed that the
funding levels suggested in many recent proposals will not support
the forces they are meant to. Such military plans are apt to leave
the United States with substantial commitments but a hollow force
incapable of carrying out its mission. If the United States is to enjoy
a significant peace dividend, the current strategic vision must be
revised. A revision would not only provide substantial savings, it
would eliminate the risk of becoming involved in peripheral con
flicts for which U. S. forces are not prepared.
A fundamental feature of a new security policy should be renunci
ation of the reflexive desire to intervene militarily whenever crises
arise. The policy of intervening in areas of dubious value to the
United States has been costly and often counterproductive, as
events in Vietnam and Iran (the CIA-directed coup that restored
the shah to power) demonstrated. The alternative to that approach
is to strictly define the security interests of the United States. To
be a threat to a vital interest, an external development must be
truly life threatening to the Republic. The emergence of a global
288
Militar Budget
military power with an expansionist ideology would constitute such
a threat. A threat to vital interests could also take other forms, but
currently such a challenge could come only from hostile states
armed with nuclear weapons. However, that menace is best met
through development of an anti-ballistic missile (ABM) system and
multilateral efforts to control nuclear technology and weapons pro
liferation. An enormous standing army or an excessively large navy
will do little to provide a credible deterrent to a renegade party
armed with nuclear weapons.
A strategy based on a rigorous definition of vital interests would
mean that the American military would intervene only where criti
cal threats to vital U. S. interests developed. If such a policy were
adopted, the United States could reduce its security commitments
throughout the world. The U. S. military would not be charged
with defending other countries. Since threats to the United States
are receding, it is unlikely that major challenges will develop in
the near future. Commenting on the lack of potential American
enemies, Chairman of the Joint Chiefs of Staff Gen. Colin Powell
has stated: "I'm running out of demons. I'm running out of villains.
I'm down to Castro and Kim II Sung.
,,
14 That assessment concedes
the paucity of real threats to the United States.
A more appropriate strategy would allow military spending lev
els, designed to counter a global enemy, to be signifcantly reduced.
The United States could reduce defense spending by about one
half over the next several years and more than adequately protect
national security interests. 15 Military expenditures of approximately
14
Newsweek, April Z, 1991, p. 19.
Ishe numbers given here are drawn from Ravenal's Designing Defense for a New
World Order and Ted Galen Carpenter and Rosemary Fiscarelli, "America's Peace
Dividend," Cato Institute White Paper, August 7, 1990. A number of other studies
have advocated cuts of a similar magnitude. William W. Kaufman and John Stein
bruner suggest a "cooperative security" system that would require a military budget
of $146.8 billion in Decisions for Defense: Prospects for a Ne Order (Washington:
Brookings Institution, 1991), pp. 67-76. Their preferred option would consist of a
multilateral agreement among the major powers to limit military capabilities and
regulate arms exports. Kaufman and Stein bruner believe such an agreement would
eliminate many of the dangers inherent in the international system. The Center for
Defense Information argues that all of the goals of the Pentagon's National Military
Strategy can be met for $212 billion ("Defending America: A Force Structure for
1995," Center for Defense Information, February 21, 1992). Even the DOD has
prepared to deal with a lower budget than that envisioned for the Base Force concept
(Eric Schmitt, "Military Planning Deep Budget Cuts," New York Times, August 30,
289
MARKET LIBERLISM
$150 billion (1993 dollars) would support a force of 1 million person
nel including 6 Army divisions, 2 Marine divisions, 11 Air Force
tactical air wings, and 6 carrier groups with 5 air wings. A military
of that size would consist primarily of air and naval power and
would focus on rapid response deployments, not large-scale mis
sions designed to counter the former Soviet Union. The United
States will not need massive numbers of ground troops since it is
faced with no imminent global military challenge. With a scaled
down military, the United States would not only have capable
conventional forces; it could afford to maintain a credible nuclear
deterrent and continue funding for an ABM system and other
research programs. A force of the suggested size could serve as a
base from which to reconstitute a larger military if the United States
were threatened in the future. An appropriate budget would also
include funds for the intelligence services, albeit at reduced levels.
Their mission would be to ensure that, should maj or threats
develop, Washington would have the time to prepare accordingly.
A $150 billion U. S. military budget would still be over four times
larger than that of any other industrial power. It would allow the
United States to guarantee its territorial integrity, maintain its place
as the world's dominant naval power, and continue the develop
ment of new technology as a hedge against a resurgent global
threat.
The proposed reduction would require disengaging from many
of our overseas commitments and demobilizing U. S. -based forces
designed specifically to fight Soviet aggression on foreign soil.
Deployment of massive numbers of American personnel in Europe
and East Asia to counter an enemy that has disappeared is an
obsolete tactic. Weapons developed to counter the Soviet threat,
such as the Seawolf submarine and the B-2 bomber, would also be
eliminated. The resulting peace dividend could be returned to those
who paid for the U. S. share of the Cold War in the first place, the
American people. Dollars not spent on obsolete submarines or
missiles, items that do not contribute to further economic develop
ment, would go to economically productive areas such as civilian
investment or consumption. The result of a reallocation would be
1992, p. AI). A senior Army official predicted that future defense budgets would
b in the $240 billion to $250 billion range.
290
Militar Budget
a dramatic upsurge in the U. s. economy, the true foundation of
American power.
Conclusion
The United States has no legitimate reason to continue spending
more money on defense than all of the other G-7 industrial powers
Gapan, Germany, France, Italy, the United Kingdom, and Canada)
combined. One must seriously question the wisdom of asking
Americans to pay, on a per capita basis, hundreds of dollars more
for defense than do citizens of Britain, Germany, or Japan. Changes
in the international environment present the opportunity to achieve
a real peace dividend if America is willing to adopt a new vision
of defense strategy. Washington must curtail its reflexive desire to
intervene with force in disputes that do not threaten vital interests
of the United States. Military expenditures will have to remain
roughly constant if the nation intends to play the role of world
policeman. If spending is cut dramatically while commitments
remain the same, the United States runs a serious risk of becoming
involved in costly conflicts for which it is not adequately prepared.
There is a real alternative. The United States can reformulate its
national military strategy to refect the demise of the Soviet threat.
To implement that security policy, Washington should take the
following steps.
Over the next several years, reduce defense spending from its
current level of nearly $300 billion to $150 billion (1993 dollars) .
That amount would support a force of 1 million personnel includ
ing 6 Army divisions, 2 Marine divisions, 1 1 air wings, and 6
carrier grou ps.
Emphasize defense of the United States, not the Cold War goal
of fighting Soviet armies across the globe. Reduce infantry forces
and focus on rapid response deployments and air and naval
power.
Adjust the national military strategy to reflect the new budget
by withdrawing from overseas commitments that are not directly
related to vital U. S. security interests. That should be done gradu
ally to allow allies ample time to adjust their own defense policies.
Reject security strategies that tie large U. S. defense budgets to
quixotic goals such as global democracy or stability.
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Encourage extensive economic, cultural, diplomatic, and social
links with other nations. A restrained foreign policy is not a policy
of "Fortress America. "
Reject proposals to maintain a large defense budget for economic,
social, or political purposes. Civil concerns are most effectively
addressed through other institutions.
Return the money saved by defense reductions to the American
peopl e. Moving scarce resources away from inefficient and
unnecessary military programs into the private sector would
stimulate the U. S. economy.
The end of the Cold War should be a time of celebration and
relief since the United States no longer faces a global military threat.
It should not be a time when the nation looks abroad "in search
of enemies, " as Ted Galen Carpenter puts it. An appropriate
post-Cold War military strategy would produce a significant peace
dividend, thus fueling the stagnant U. S. economy and vastly reduc
ing the chances that the country would be drawn into a conflict
that was peripheral to its national interests.
292
1. Dangerous Panacea: A Stronger
United Nations
Dou
g
Bandow
The collapse of the Soviet Union and the end of the Cold War have
forced a long-overdue reevaluation of American security policy.
Traditional containment is dead, since there is no longer an oppos
ing, hegemonic power to contain. What new strategy, then, should
replace containment?
One increasingly touted alternative strategy is collective security
through both regional organizations and a revitalized United
Nations. At its extreme, such a system would seek to control every
confict everywhere. Writes Anthony Arend of Georgetown Univer
sity, "Although a conflict may seem quite removed, the theory of
collective security holds that if an act of aggression anywhere goes
unchallenged, the security of all states is threatened. "l That
approach, or even one committed to responding only to the most
serious conflicts, is inherently interventionist.
A diluted form of collective security has long been an important
aspect of American foreign policy. For instance, the United States
is a member of several regional security organizations, including
the North Atlantic Treaty Organization (NATO), through which
collective military action can be undertaken. Washington obtained
the United Nations' imprimatur for combat in South Korea and,
more recently, in the Persian Gulf and has long supported UN
peacekeeping efforts in various parts of the globe.
Collective security is being advanced today under the rubric of
President George Bush's "new world order," but its roots go back
to Woodrow Wilson's crusade for democracy and his successful
campaign to pull the nation into World War I . As the world enters
a period during which the international environment may grow
'Anthony Arend, Pursuing a Just and Durable Peace: John Foster Dulles and Interna
tional Organizations (New York: Greenwood, 1988), p. 39.
293
MARKET LIBERALISM
more chaotic even as threats to U. S. security decline, the question
is whether it would be wise for the United States to "strengthen"
collective security, particularly by granting the United Nations more
authority to mount military operations to punish aggressors and
perhaps even settle civil wars.
Collective Security: The United Nations
The most idealistic version of the collective security strategy today
is grounded in reliance on the United Nations. The allied success
in World War II led to a widespread desire for an international
regime to achieve what Woodrow Wilson had expected his ill-fated
League of Nations to deliver: an international order collectively
policed by the nations of the world.
In theory the United Nations has enormous authority. The UN
Charter explicitly vests the Security Council with primary responsi
bility for the maintenance of international peace and security. Arti
cle 42 empowers the Security Council to use armed force " as may be
necessary to maintain or restore international peace and security. "
Article 45 orders member states to make available national air force
contingents for combined international enforcement measures so
that the United Nations can "take urgent action. " Plans for military
actions are to be drafted by a Military Staff Committee (MSC).
Article 43 even outlines procedures for the United Nations to follow
in raising a military. Most of those provisions have never been used,
however, largely because the Cold War disrupted the expected
continued allied cooperation as the Soviet Union used its veto to
deadlock the Security Council .
With the end of the Cold War and Moscow's cooperation in the
Persian Gulf War, some observers wish once again to embrace the
original promise of the United Nations. When he appeared before
. the that body in October 1990, Bush declared, "Not since 1945 have
we seen the real possibility of using the United Nations as it was
designed, as a center for international collective security.
,
,
2 Others
have echoed Bush's idea. Yale's Bruce Russett and former UN
official James Sutterlin wrote, "The use of military force by the
United Nations for both of these purposes-enforcement and
2
"Transcript of President's Address to U. N. General Assembly," Ne York Times,
October 2, 1992, p. A12.
294
United Nations
peacekeeping-is surely essential to a world order in which interna
tional security is heavily dependent on the Security Council. "]
Little more was heard about rejuvenating the collective security
role of the United Nations until months after the Yugoslavian crisis
began in 1991 . Former secretary of state Cyrus Vance, who had
been the UN special envoy to Yugoslavia, urged the United States
to strengthen its participation in the international organization's
peacekeeping process. Soon thereafter Bush advocated an expan
sion of UN peacekeeping. "Because of peacekeeping's growing
importance as a mission for the United States military, we will
emphasize training of combat, engineering and logistical units for
the full range of peacekeeping and humanitarian activities," he told
the United Nations. 4
Secretary General Boutros Boutros-Ghali of the United Nations
went much further. He issued a report, "Agenda for Peace, " that
advocates fulfilling Article 43 by giving the United Nations
increased military capabilities. In September 1992 the European
Community endorsed several of his proposals, including the dis
patch of UN troops to nations threatened by invasion, and the
Security Council established a working group to review his pro
posals.
Several suggestions for expanding the United Nations' collective
security role have been advanced by other analysts and public
official s. In early 1991 French president Francois Mitterrand pro
posed revitalizing the MSC, after which his country would put
1, 000 soldiers at the disposal of the United Nations on 48 hours'
notice and another 1, 000 within a week. Former UN under secretary
general for political affairs Brian Urquhart suggested using Article
43 to provide the United Nations with suffcient forces to intervene
in Yugoslavia and Somalia, as well as other nations where "sover
eignty is dissolving into anarchy.
,,
5 Harvard political scientist
Joseph Nye proposed the creation of a UN "rapid deployment
force" of 60,000 soldiers, with a core of 5,000 troops who would
3Bruce Russett and James Sutterlin, "The U. N. in a New World Order," Foreign
Afairs 70 (Spring 1991): 70.
1"homas Friedman, "Bush, in Address to U. N. , Urges More Vigor in Keeping
the Peace," Ne York Times, September 22, 1992, p. A14.
sBrian Urquhart, "Who Can Stop Civil Wars?" Ne York Times, December 12,
1991, p. E9.
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MARKET LIBERALISM
train regularly. The rapid deployment force would not be adequate
to contain large-scale aggression, such as that against Kuwait, or
a major civil war, such as the one in Yugoslavia, Nye admits. In
those cases an American-led coalition would be necessary.
Plenty of people seem to believe that ambitious UN military
operations will be necessary in various regions. Columnist Jim
Hoagland, for example, envisions a UN operation backed, but not
led, by the United States to suppress the Yugoslavian conflict.
Columnist Charles Krauthammer, among others, has proposed
turning Somalia into a UN protectorate, and Russian foreign minis
ter Andrei Kozyrev has suggested creating UN trusteeships for
some former Soviet republics. The potential targets of military
action do not end there. Argues David Scheffer of the Carnegie
Endowment for International Peace, "The number of candidates
for humanitarian intervention, " including forcible action under the
aegis of the United Nations "continues to grow as the new world
disorder takes hold. "6
Of greatest potential impact on Americans was the willingness
of both presidential candidates in the 1992 elections to edge the
United States toward involvement, through the United Nations,
in the confcts in both Yugoslavia and Armenia-Azerbaijan. Bill
Clinton, for instance, suggested American participation in air
attacks on positions from which the Serbs were besieging Sarjevo
and advocated that Washington work in concert with the United
Nations to peacefully settle the conflict over Nagorno-Karabakh.
The Bush administration agreed to the positioning of 5,000 NATO
troops (though no American forces) in Yugoslavia to safeguard UN
relief convoys and seriously considered helping bar the flight of
Serbian aircraft over Bosnia-Herzegovina.
Models for UN-Organized Collective Security
Two different models have been offered for expanding the United
Nations' collective security responsibilities. The first is that of the
organization's traditional peacekeeping activities. The second is
that of the organization's involvement in the major wars in Korea
and Iraq.
6David Scheffer, "Toward a Modern Doctrine of Humanitarian Intervention,"
Universit of Toledo Lw Revie 23, no. 2 (Winter 192): 274.
296
United Nations
Peacekeeping
The United Nations is currently undertaking 13 different peace
keeping operations that involve nearly 51, 000 soldiers, all volun
teered by their respective governments. The enterprises vary dra
matically in scope, ranging from 40 observers in Kashmir to a pro
jected 22,000 participants in Cambodia. Other UN forces are
stationed in Angola, Bosnia, Croatia, Cyprus, EI Salvador, the
Mideast, Somalia, and the Western Sahara. And proposals have
been made to establish UN peacekeeping forces elsewhere.
The major controversy surrounding UN peacekeeping today is
cost. Under antiquated rules, the United States is to provide 30
percent of the funding, and the recent rapid expansion of UN
activities caused the Bush administration to request a $350 million
supplemental appropriation in addition to the $107 million origi
nally approved in 1992, as well as $460 million more for 1993. Those
funds are by no means certain to be allocated by Congress, since
the United States is currently $208. 7 million in arrears on its peace
keeping assessments. Nevertheless, Secretary of State James A.
Baker I I I called the outlays "a pretty good buy,
,,
7 and other UN
supporters express similar views. A report from the Henry L. Stim
son Center, for example, contends that "the U. N. is our cheapest
alternative for containing and resolving conflict. "s
Major Wars
Quite different from the UN peacekeeping operations were the
two large-scale conflicts undertaken under the authority of the
Security Council. In 1950, with the Soviet delegate boycotting the
Security Council to protest the failure to seat China's new revolu
tionary government, the Security Council authorized the creation
of a multinational force to repel North Korean aggression against
the Republic of Korea. Gen. Douglas MacArthur of the U. S. Army
was designated commander of the UN forces, but he never reported
to the Security Council, and Washington unilaterally made all of
the war's major decisions-to cross the 38th parallel, for instance,
and to refuse forced repatriation of prisoners.
7Quoted in "Paying for Peace," U. S. News & World Report, March 16, 1992, p. 9.
8George Moffett, "UN Peacekeeping Is Costly 'Bargain' to US," Christian Science
Monitor, March 16, 1992, p. 8.
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The UN forces were predominantly American forces that joined
Seoul's numerically strong but qualitatively weak forces. Ninety
percent of the non-South Korean troops were Americans. Casual
ties showed a similar distribution. Some 47,000 Korean and 36,823
non-Korean servicemen died. Of the UN contingent, 33, 629, or 91
percent, were Americans.
The Security Council didn't create a UN joint command for the
Persian Gulf War. Although the United States formally observed
the conditions of the Security Council's resolutions, Washington
had considerable latitude in deciding how to implement them.
Once again America provided the bulk of the UN forces-Sl0, 000,
or 80 percent, of roughly 652,600 combat troops. The U. S. death
toll, a mercifully low 148, also constituted the bulk of the allied
casualties.
Is Collective Security Desirable?
Collective security assumes that it is in America's interest to work
to eliminate international disorder and instability by preventing
aggression and squelching civil conflicts. Indeed, the cornerstone
of a policy of collective security is stability. Whatever the formal
rhetoric of policy makers about human rights and democracy, the
primary goal of collective security is to prevent unauthorized border
crossings and ensure the survival of particular internal political
systems. Observes Arend: "States must also be willing to act no
matter how 'just' the cause of aggression may seem to be. In this
system, the international community has determined that the high
est goal of the system is the preservation of peace; even 'just causes'
do not j ustify aggression.
,,
9
Instability in the post-Cold War world is inevitable and should
not come as a surprise. For decades the two superpowers were
largely successful in suppressing often severe cultural, ethnic, lin
guistic, nationalistic, and religious differences within allied states.
Moscow, for instance, would not tolerate a conflict between Hun
gary and Romania over disputed Transylvania, and the threat of
9Arend, pp. 39-. Obviously, his approach differs substantially from those of
such "democratists" as Joshua Muravchik and Gregory Fossedal, who would focus
the attention of national and multilateral institutions on encouraging the spread of
political democracy. Their objectives are largely divorced from security concers
and may, in fact, undermine the goal of stability.
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United Nations
Soviet intervention held Yugoslavia together. The West backed
Mobuto Sese Seko's rule over Zaire's disparate peoples. Many of
the conflicts now surfacing around the world are entirely legitimate
and long overdue.
Of course, it would be best if previous political settlements, how
ever artificial, were not challenged violently. Even assuming that
Iraq had legitimate grievances against Kuwait, the former was not
justified in invading the latter. But the fundamental issue is how
to best advance America's security. (Fostering respect for human
rights in other nations is obviously an important moral value, but
the foremost duty of the U. S. government is to protect the American
people's lives, property, freedom, and constitutional system. )
The question, then, is, Does maintaining the international status
quo make America more secure? The answer is that it is not in
America's interest, nor is it feasible, to act as the star player on a
collective security team.
It should be obvious that global disorder per se does not threaten
the United States. If Washington was wrong to view every locai
conflict as instigated by the Soviet Union during the Cold War, at
least that perspective was understandable. Given their ties to a
threatening hegemonic power, Soviet surrogates could conceivably
have harmed American security interests by attacking nations allied
with the United States. Alas, Washington's devotion to stability
led it to make many a bargain with the devil, or at least with
his surrogates. American aid for Iran's shah, Nicaragua's Somoza,
Zaire' s Mobuto, the Philippines' Marcos, and Sudan's Nimiery
placed the United States on the side of unsavory regimes and cre
ated anti-American sentiments, which still animate the Iranian and
Sudanese governments, for instance.
In any case, the end of the Cold War has terminated the poten
tially zero-sum nature of international relations. The disintegration
of Somalia, a U. S. ally, is tragic but has few security implications.
Liberia's three-sided civil war threatens no important American
interests.
Washington can view even the Yugoslavian civil war, in the ever
unstable Balkans, with detachment. Some people have, of course,
advanced lurid scenarios involving the conflict's spreading to Alba
nia, Greece, Turkey, and beyond, but a year has passed without the
bloodshed expanding. Absent the interlocking alliances, worsening
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tensions, and widespread popular support for war that character
ized all of the major powers, conflict in the Balkans in 1914 would
never have spread to the rest of Europe, let alone America. It is
difficult to construct an even slightly plausible chain of events that
could lead to a similar global war today. If the risk is still thought
to be serious enough to warrant action, then the Europeans, who
have the most at stake, should take action. If they do not judge
the costs of intervening to outweigh the benefits, there is certainly
no reason for Washington to act.
But what about the Persian Gulf? Many advocates of collective
security view it as proof of the need for an ongoing, formal system
for stifling aggression. Turmoil or aggression in the gulf region,
they contend, would inevitably threaten American security.
In fact, reliance on the Persian Gulf as an example of the need
for collective security demonstrates the weakness rather than
strength of the case. It is impossible to point to any other regional
conflict with as far-reaching implications for the United States.
Chaos and aggression in Africa, war between Argentina and Chile,
a bloody eruption in Kashmir, and even a North Korean invasion
of the ROK (in the absence of a U. s. security guarantee and U. s.
troops) all would be human catastrophes, but none would do more
than disrupt commercial relations and concern Americans with
relatives and friends in the affected nations. Assuming that the
United States does not plan to go to war for mercantilistic or human
itarian purposes, there is no reason for a U. s. -dominated collective
security mechanism to deal with such conflicts.
Iraq's invasion of Kuwait could also have been treated as a limited
threat best met by other regional powers. Although the issue is
too complicated to deal with in detail here, the basic case against
an American-organized response in the name of collective security
is threefold.
First, the protection of Saudi Arabia, not the liberation of Kuwait,
was the primary U. S. interest. Iraq's seizure of Kuwait alone, while
brutal, did little to change the region's balance of oil or power.
Yet to have attacked as vast a land as Saudi Arabia would have
dangerously overstretched Baghdad's forces, a fact apparently rec
ognized by Saddam. Even as Defense Secretary Richard Cheney
was in Riyadh pressuring the Saudis to accept American interven
tion, the Pentagon was being told by a U. S. military official inside
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Kuwait that Saddam had withdrawn his elite Republican Guard
units into Iraq, hardly an indication that he intended to invade
Saudi Arabia. lO
Second, Iraq's neighbors, particularly a revenge-minded Iran,
were capable of containing Saddam. Syria alone possessed nearly
as many tanks as did Iraq. Had the countries surrounding Iraq,
which were in the best position to judge Saddam's capabilities and
intentions, feared further aggression, they could have acted to
contain him. 1 1 Of course, such cooperation between distrustful
states is neither as easy nor as effective as U. S. -orchestrated action.
Intervention, however, is never cost free for the United States.
Washington should attempt to develop, not the theoretically perfect
response, treating expense as irrelevant, but the best one given the
very real costs of different options. In the case of Iraq, the best
response would have been to encourage the states with the most
to lose from further Iraqi expansion to forge a defensive alliance.
Indeed, regional arrangements are an obvious solution to many
disputes. In November 1990 five nations-Gambia, Ghana, Guinea,
Nigeria, and Sierra Leone-dispatched 7,000 soldiers under the
aegis of the Economic Community of West African States to police
a cease-fire between three competing factions in a devastating civil
war in Liberia. Although real peace has not yet been attained, the
multinational effort has survived severe trials and appears to be
making progress in forging a settlement. In 1991 Australia, New
Zealand, the Soloman Islands, and Vanuatu created a multinational
supervisory team to break Papua New Guinea's blockade of the
Pacific island of Bougainville. Russia has joined Georgia in attempt
ing to establish a buffer zone in the territory of South Ossetia in
Georgia. And for a time the European Community considered tak
ing military action in Yugoslavia, in an attempt to enforce several
EC-sponsored cease-fires. Although the European Community
eventually encouraged the United Nations to send peacekeepers;
IOStaff of U. S. Nes & World Report, Triumph without Victor: The Unreported Histor
of the Persian Gulf War (New York: Random House, 1992), pp. 97-98.
llSee, for example, Ted Galen Carpenter, "Bush Jumped the Gun in the Gulf,"
Ne York Times, August 18, 1990; Christopher Layne and Ted Galen Carpenter,
"Arabian Nightmares: America's Persian Gulf Entanglement, " Cato Institute Policy
Analysis no. 142, November 9, 1990; and Christopher Layne, "Why the Gulf War
Was Not in the National Interest," Atlantic, July 1991.
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the Europeans were considering rejuvenating the heretofore mori
bund Western European Union (WEU), long intended to serve as
a European defense organization. Although all of those efforts are
small in comparison with the gulf war, they illustrate the possibility
of relying on cooperative efforts among the parties most concerned
about potential conflict in a region.
The nuclear question poses a particular problem for efforts at
regional containment, but it did not motivate Washington's inter
vention in the Persian Gulf. Only after polls in the late fall of
1990 showed Iraq's atomic weapons program to be of great public
concern did the Bush administration focus on that issue. Unfortu
nately, the spread of nuclear weapons seems inevitable, since the
cost of attempting to forcibly disarm every potential atomic power
(e. g. , Iran, North Korea, and Pakistan) is likely to be prohibitive.
The best hope may ultimately be regional power balances, with
even a Sad dam, should his efforts ever succeed, constrained by
Israel's nuclear weapons, for instance.
Third, Saddam was never in a position to gain a "stranglehold"
on the West's oil supply and thus its economy. The focus on oil
reserves was misleading, since those reserves are not total geologic
deposits but supplies economically recoverable at present prices. In
fact, Saddam increased estimated world oil reserves by his invasion,
since it raised world oil prices. The relevant measure was oil produc
tion, and even had Iraq conquered the entire gulf region, Baghdad
would have controlled little more than one-fifth of the international
petroleum market. Such a share would have allowed Iraq to increase
oil prices, but only modestly. One detailed economic analysis esti
mated the maximum likely jump in America's oil bill at $29. 2 billion
annually, roughly one-half of 1 percent of gross national product
and less than the added cost of the Clean Air Act amendments
approved by Congress in 1990. 1
2
But one's personal judgment of the necessity of America's inter
vention in the gulf is less important than recognizing that Iraq's
aggression posed a worst-case scenario for the rest of the world.
However compelling the case for action against Saddam, his aggres
sion does not prove the need for some international mechanism,
1
2
David Henderson, "The Myth of Saddam's Oil Stranglehold," in Americ Entan
gled: The Persian Gulf Crisis and Its Consequences, ed. Ted Galen Carpenter (Washing
ton: Cato Institute, 191), p. 43.
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backed by the United States, to maintain "order. " In most cases,
instability poses little danger to America and can be contained by
other states or ignored entirely.
What if, in the future, an international incident suffciently seri
ous to warrant intervention arises? Then the United States should
help organize an ad hoc force, either through the United Nations
or with like-minded countries, to meet the specifc threat. The
standard for American participation should be the same as it is for
unilateral military action: a vital rather than peripheral interest is
at stake (and therefore warrants the sacrifice of life, potentially
huge expense, and other risks inherent to foreign intervention);
there are no other powers that can meet the challenge; and no
peaceful alternatives exist for resolving the issue.
Is Collective Security Feasible?
The objection to collective security is not purely theoretical. There
are also a number of practical pitfalls. Given the low esteem in
which most Americans held the United Nations throughout the
1970s and 1980s, the notion of using it to police the world would
probably be considered a joke were it not for the Persian Gulf
War, which President Bush declared had rejuvenated the United
Nations' peacekeeping function. 13 But now serious commentators
want to give the international body its own military.
Is such an approach feasible? "For a collective security system
to work, " argues Arend, "there must be an absolute commitment
of all states. They must be willing to combat aggression, wherever
and whenever it may occur. " As impartial judges, countries "must
also be willing to act no matter who the perpetrator may be. Special
relationships or alliances are not allowed to interfere with the duty
of states to confront aggression. / l14
Unfortunately, the United Nations has never demonstrated a
capacity to impartially settle international disputes. 15 Moscow's
13Staff of U.5. Nes & World Report, p. 176.
14Arend, p. 39.
15Among the more egregious examples of the politicization of the United Nations
was the multiyear campaign for a "new international economic order." See, for
example, Doug Bandow, "Totalitarian Global Management: The U. N. ' s War on the
Liberal International Economic Order, " Cato Institute Policy Analysis no. 61, Octo
ber 24, 1985. More broadly, international organizations, particularly those within
the UN system, have often contributed to global problems. Some people, writes
Giulio Gallarotti, "have traditionally been overly optimistic about the ability of
multilateral management to stabilize international relations and have generally
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new willingness to cooperate should not obscure the fact that for
45 years the United Nations was merely another Cold War battle
ground. In fact, the failure of the UN collective security system
fueled the expansion of regional alliances. Even today UN policy
is at the mercy of the communist rulers in Beijing who, despite a
demonstrated willingness to shoot down unarmed students and
workers, possess a veto in the Security Council. And while more
states are moving toward democracy, a majority of the members of
the United Nations are still dictatorships. Thus, even if the growing
number of free states survives, in the near future collective security
is likely to be ineffective if the aggressor is a permanent member
of the Security Council, a client state of a permanent member, or
a country able to amass eight votes from the Security Council's
15 member countries, many of which will still be ruled by venal
autocrats. Indeed, it is conceivable that even Western democracies
might act to shield friendly states from UN censure and enforce
ment action. Consider Washington's probable attitude should Israel
or South Korea launch a preemptive attack against Syria or North
Korea, respectively.
The flip-side risk is that increased "peacekeeping" authority
might cause the United Nations to shift toward an greater enforce
ment role not necessarily related to peacekeeping. That is, it might
become a coercive tool in the hands of shifting international majori
ties that happened to control the Security Council at any given
time. That would be of particular concern if the United Nations
possessed its own military. Although the United States could
always veto what it viewed as inappropriate intervention, it would
pay a political price for doing so. Moreover, a recalcitrant Washing
ton could then hardly count on Security Council support when it
wanted UN support for military action.
The United Nations seems unsuited to the task of maintaining
global order. Neither of the suggested models for UN enforcement
of collective security offers much hope. True, traditional UN peace
keeping may help prevent small incidents that could spread and
thereby threaten a fragile peace accord, and may give responsible
ignored the fact that [international organizations) can be a source of, rather than a
remedy for, disorder in and across issue-areas. " Giulio Gallarotti, "The Limits of
International Organization: Systemic Failure in the Management of International
Relations," International Organiztions 45 (Spring 1991): 218-19.
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United Nations
officials an excuse to resist domestic political pressure to provoke
a conflict. In the end, however, UN peacekeeping can only prevent
fighting if both parties desire peace for other reasons. For instance,
it is Israel's military superiority, not the presence of UN troops,
that prevents Syria from attempting to reclaim the Golan Heights.
The risks involved help deter India and Pakistan from waging a
full-scale war over Kashmir, regardless of the activity of UN forces.
UN peacekeepers arrived in Croatia only after the costs of war had
compelled both Serbian and Croatian leaders to seek a respite from
the fighting. And the patrons of the different combatants in Cambo
dia, not the United Nations, brought an end to the tragic fighting
in that nation. UN forces in the Sinai did not prevent the 1967 war
between Israel and its neighbors; UN troops in Lebanon today do
not constrain Israeli, Palestinian, or Shi'ite military activity. In
short, the United Nations cannot stop a war that is being waged
by determined belligerents.
There are many other, secondary criticisms of UN peacekeeping,
including that the efforts are expensive and often persist for decades
with little apparent result. For example, UN peacekeeping forces
have been in Cyprus for more than 16 years and have had virtually
no effect on the de facto partition of that country.
The United Nations' peace-enforcement record is even less
impressive. The major wars fought under the UN flag were UN
operations in name only. Observes M. V. Naidu of Canada's Bran
don University, "The most important factor" in the Korean action
"was the preparedness of a superpower like the United States to
provide everything neces
.
sary for the action and to take complete
charge of conducting the operations. " America's commitment to
intervene, even without allied support, was also the most important
factor in the Persian Gulf War. While UN authority was a conve
nient and politically popular patina, it was not necessary to prosecu
tion of the war.
Nevertheless, the United States had to pay a price for the United
Na tions' imprima tur. Washington's desire for Soviet support forced
the administration to ignore the USSR's crackdown in the Baltic
states. China's abstention from the critical Security Council vote
authorizing the use of force appears to have been purchased by
new World Bank loans, which were approved shortly thereafter,
possibly supplemented by reduced pressure on human rights
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issues. And consider the 10 nonpermanent members who had a
voice in shaping Persian Gulf policy: Austria, Belgium, Cuba, Ecua
dor, India, the Ivory Coast, Romania, Yemen, Zaire, and Zim
babwe. Many of those nations were interested in gaining additional
Western financial assistance, if nothing else. And the United States
was not above using its aid policies to procure votes. Secretary of
State Baker responded to Yemen's opposition to the resolution
authorizing the use of force with a note to Yemen's ambassador
stating, "That is the most expensive vote you have ever cast. "16
While such log-rolling might be expected, it hardly augurs well for
the creation of an effective-much less an equitable-system of
collective security.
In the future other nations might expect not only bribes but also
real influence. Mitterrand, for instance, apparently advanced his
proposal to rejuvenate the MSC envisioned by article 45 of the UN
Charter because the committee would break America's military
monopoly on UN actions. His foreign minister later argued that
Europe and the United Nations should help counteract U. S. power.
"American might reigns without balancing weight, " he com
plained. 17 Increasingly wealthy and influential Germany and Japan
may demand not only permanent seats on the Security Council but
also a say in future military operations. Similarly, India, which
possesses a potent military, may not be quiescent in the future.
In fact, Brazil's foreign minister has proposed expanding Security
Council membership, though without a veto, not only to Germany
and Japan, but also to Brazil, Egypt, India, Nigeria, and other states.
There is nothing intrinsically wrong with the French desire to
turn what has been a Potemkin collaborative security enterprise
into a real one. But it is doubtful that a system subject to the vagaries
to which any international organization is subject is going to either
achieve its purpose or advance American interests. Not only might
the United Nations be unduly restrictive when Washington felt
intervention was necessary, but more important, a truly honest
16Staff of U. S. News & World Report, p. 181.
17"France to U. S. : Don't Rule," New York Times, September 3, 1991, p. A8. After
the June 1991 NATO conference, French officials also grumbled about Washington's
highhandedness in the wake of its victory in the gulf war. William Drozdiak, "U. S.
Shows Arrogance to Allies, French Say," Washington Post, June 12, 1991, pp. A25,
A26.
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United Nations
collective security system could drag the United States into conflicts
that had no connection to American interests and that could be
solved without Washington's assistance. What if, for instance, Ger
many, France, Italy, and Greece demanded Security Council mili
tary action in Yugoslavia? Or if Turkey, Russia, and Armenia pro
posed UN intervention in Azerbaijan? Should the United States
again become the major combatant, perhaps consigning thousands
of citizens to their deaths in a potentially interminable conflict with
no impact on American security? To vest the United Nations with
significant peacekeeping power requires that one trust a council
including 14 foreign states more than one's elected government.
Past experience does not warrant placing that kind of confidence
in the Security Council.
The proposal to give the United Nations an independent combat
force to be used at the Secretary General's discretion is even less
prudent. Whatever the international body's value may be as a
debating chamber within which to let off steam, it has never demon
strated principled leadership unhampered by multitudinous and
arcane political pressures. Today, of course, the potential for abus
ing the United Nations is tempered by the role of the Security
Council, but if the United Nations gained the sort of influence that
would come with an independent armed force, a coalition of smaller
states might attempt to move security power back to the General
Assembly. In fact, the nations represented at the recent Nonaligned
Movement summit agreed to create a "high-level working group"
to develop proposals for the "democratization of the United Nations
system. " They went on to denounce "those who seek to preserve
their privileged positions of power. Ironically, the United States
itself sought to circumvent the Soviet veto in the Security Council
during the 1960-61 UN intervention in the Congo by appealing to
the General Assembly's "uniting for peace resolution" and thereby
set a dangerous precedent. As long as the United Nations is gov
erned by a majority of nation-states, ruled by some of the worst
people on earth, it should not be trusted with even one soldier.
Conclusion: Regional Peacekeeping without the United States
The dramatic international changes of recent years have truly
yielded a "new world order" that provides America with a unique
1
8
WiIliam Branigan, "North and South Stand Worlds Apart on Reform, " Washing
ton Post, September 23, 1992, p. A32.
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opportunity to reassess its global role. For nearly five decades the
United States has acted more like an empire than a republic, creating
an international network of client states, establishing hundreds of
military installations around the world, conscripting young people
to staff those advanced outposts and fight in distant wars, and
spending hundreds of billions of dollars annually on the military.
Washington's globalist foreign policy has badly distorted the
domestic political system by encouraging the growth of a large,
expensive, repressive, secretive, and often uncontrolled state.
The justification for that interventionist military strategy, so alien
to the original American design, was the threat of totalitarian com
munism. With that threat gone, the United States should return
to its roots rather than look for other adversaries and embark on
global interventionist crusades. It should become, in the words
of former ambassador to the United Nations Jeane Kirkpatrick, a
"normal country" again. And that requires a much more limited
foreign policy with much more limited ends.
Most fundamental is the question of American interests. Put
bluntly, what policy will best protect the lives, property, freedom,
and constitutional system of the people of this nation? Entangling
Washington in a potentially unending series of international con
flicts and civil wars through the United Nations? Or remaining
aloof from struggles that do not affect the United States? If our
chief concern is preserving American lives and treasure, the latter
position is clearly preferable.
To begin t o implement a less interventionist foreign policy, the
new administration should take the following steps.
Reject all proposals to create an independent military force for
the United Nations.
Set a firm policy that the United States will not provide troops
for UN peacekeeping or peace-enforcement missions unless there
is a clear connection to vital American security interests.
Initiate a concerted effort to renegotiate the agreement whereby
the United States pays a disproportionate percentage of the costs
of UN operations.
Display greater willingness to use the U. S. veto power in the
Security Council to block any initiatives that impinge on Ameri
can security interests or economic and political values.
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United Nations
Today there is no Soviet Union to contain, and local and regional
quarrels are no longer of vital concern since they are no longer part
of the overall Cold War. Moreover, those states that were once
possible victims of aggression-underdeveloped Korea, defeated
Germany and Japan, war-torn France and Britain, and such smaller
nations as Australia and New Zealand-have developed potent
militaries and are capable of meeting any likely threats to them
selves or their neighbors. Most security concerns now can be han
dled locally or regionally rather than globally.
Global collective security mechanisms were never desirable nor
practical. A new grandiose mission for the United Nations, sup
ported financially and militarily by the United States, has even less
appeal in the post-Cold War era.
309
1o. Time to Retire the World Bank and
the International Monetary Fund
Melanie S. Tammen
We are [in Eastern Europe] confronted with factors which
have fully negative consequences upon the transformation
process . . . . Technical assistance is offered by foreign gov
ernments or international institutions which very often
employ people with a dirigistic or openly socialist outlook.
The marginal product of such activities may even be
negative . . . . [We also face] the procedures, charters,
instructions and obligations connected with membership in
international organizations-with an almost forced partici
pation. They were created in a different world and time and
they bring back approaches we are trying to get rid of.
-Vaclav Klaus
In July 1944, at the invitation of the United States, representatives
of 4 nations met at Bretton Woods, New Hampshire, to lay the
foundations for reinvigorating postwar economic relations. Under
the particular urging of British delegate John Maynard Keynes
,
they created two sister institutions: The International Monetary
Fund was to oversee a global regime of fixed exchange rates. The
International Bank for Reconstruction and Development (now
known as the World Bank) was to provide financial assistance to
the European governments to help them rebuild their shattered
economies.
By the late 1950s Europe was back on its feet and the bank's
mission was complete. Just over a decade later, in 1971, the global
system of fixed exchange rates broke down and the IMP's mission
disappeared. Yet as so often happens with bureaucracies whose
missions are complete (or discredited), the World Bank and the IMF
crafted for themselves-with the help of political and intellectual
supporters-new sets of global exigencies that purportedly ren
dered them indispensable.
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In the decades since, those institutions have extended hundreds
of billions of dollars in subsidized loans to the governments of
developing nations in Africa, Asia, Latin America, and Eastern
Europe (an average of 75 nations each year during the 1980s) . That
protracted massive intervention-and the seal of approval that it
gave to those governments' destructive, socialist economic poli
cies-encouraged the governments of developed nations (directly)
and private lenders (indirectly) to extend tens of billions of dollars
more in credit.
In large measure because of the flagship role played by the IMF
and the World Bank between 1956 and 1986, the net transfer of
capital from the developed world to the developing world (adjusted
for inflation) amounted to some $1 . 8 trillion. 1
The verdict on centralized, planned economies i s now in. They
brought ruin to Eastern Europe, a $450 billion noose of foreign debt
to Latin America, and to sub-Saharan Africa per capita incomes
that are lower today than they were in 1970.
The new refrain from World Bank and IMF officials is that reform
will not come for nothing. They argue that large sums of aid are
required to encourage and sustain "market-opening" reforms in
the developing nations and Eastern Europe and that without such
aid, reform governments might fall. That rhetoric rings hollow. The
unquestioned success of countries such as South Korea, Taiwan,
Singapore, Malaysia, Chile, and Mexico has clearly demonstrated,
for all to see, the basic elements of reform that are required to turn
economies around.
Today, as in the past, World Bank and IMF lending perpetuates
a larger role for government and planning-and a slower pace of
reform-than nations could otherwise afford. Just as important,
the continued escalation of World Bank and IMF lending programs
is transferring bad debts to Western taxpayers. That escalation is
apparent in Eastern Europe, to which the IMF and the World Bank
have extended about $10 billion in loans over the past three years.
Since 1988, for example, the World Bank has raised its annual
lending rate to the region from $300 million to about $2. 2 billion-
INicholas Eberstadt, "Foreign Aid's Industrialized Poverty, " Wall Street Journal,
November 8, 190. Original source given is the Organization for Economic Coopera
tion and Development in Paris. Figure is net of profit repatriation and loan repay
ments and does not include private charity or military aid.
312
The World Bank and the IMF
an increase of more than sevenfold. At the same time the nations
of Eastern Europe are trying to move away from centrally controlled
economies, the IMF and the World Bank are enticing them to get
"hooked" on subsidized loans.
With the verdict on central planning so clear, the United States
and other Western nations should dismantle the international lend
ing institutions that counsel and finance it-the IMF, the World
Bank, and the related regional development banks.
The Evolving World Bank: A Brief Review
In 1961, when prominent development economists were promot
ing the virtues of Soviet-style central planning and John F. Kennedy
launched a large aid program for Latin America (the Alliance for
Progress), the World Bank shifted its attention to the least credit
worthy nations. It founded the International Development Associa
tion (IDA)-a concessional lending window that would offer loans
with 50-year maturities at zero interest. (In the late 1980s maturities
were cut to 35 and 40 years. ) The World Bank continued to lend
for infrastructure, and it also placed new emphasis on lending for
industry, agriculture, and education.
Under Robert McNamara, president from 1968 to 1981, the World
Bank emphasized alleviating poverty, particularly through loans
for rural agricultural development and population control. Annual
lending expanded 14-fold, to over $12 billion, during that time.
During the 1980s the bank added a new emphasis on lending to
"support market-oriented reforms" to its continued emphasis on
loans for social programs aimed at "poverty reduction. " Such
policy-based lending grew swiftly after the advent of the debt crisis
in 1982, in response to pressure from Washington to increase "fast
disbursing" loans to help keep developing nations from defaulting
on their foreign debts. Since the mid-1980s loans in return for
promises of reform (rather than tangible projects) have constituted
between one-fourth and one-third of total World Bank lending.
The World Bank's Legac
The World Bank has created a legacy of industrialization without
prosperity and investment without growth. Since the 1960s the
bank has lent the governments of developing nations some $300
billion for public-sector investments in all manner of projects
including roads, bridges, dams, railroads, telephone companies,
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steel mills, housing projects, electricity concerns, educational pro
grams, agricultural mechanization, and government-run banks, to
name only a few. The shared wisdom of the leaders of developing
countries, Western development economists, and World Bank offi
cials held that World Bank loans could transform low-income coun
tries by funding government industrialization and social programs.
As economist and population specialist Nicholas Eberstadt argues,
it worked-if one accepts the perverse standards of the World
Bank. According to recent bank statistics on industry'S share of
gross output, sub-Saharan Africa currently looks more "industrial
ized" than Denmark. Eberstadt writes:
As for the relative share of investment, World Bank esti
mates suggest this to be lower in West Germany than in
such countries as Togo, Nepal, Egypt and Costa Rica. Recent
estimates put the investment ratio in Rwanda well above
that in Belgium; Mali's appears to be higher than France's
[and] the investment ratio appears to be higher today in the
People's Democratic Republic of the Congo than in Japan.2
To be sure, in some developing countries, such as Singapore,
Korea, and Indonesia, high rates of investment have coincided with
and been followed by rapid rates of measured increase in national
output. But in quite a few other countries, high rates of investment
have been accompanied by economic stagnation or decline. Eber
stadt points out:
In the mid-1960s, according to World Bank estimates,
the ratio of gross domestic investment in such countries as
Nicaragua, Bolivia, the Central African RepubliC, Zambia
and Jamaica was higher than in the United States. During
the following two decades, however, per capita output in
these countries registered a decline. The per capita growth
rate, in other words, was negative. 3
When investment produces such low, and even negative, rates
of return year after year, one would expect competitive economic
2
Ibid.
3NichoIas Eberstadt, "Investment without Growth, Industrialization without
Prosperity, " Journal of Economic Growth 3, no. 4 (Summer 1989): 20.
314
The World Bank and the IMF
forces to reduce the amount of capital that went to such unproduc
tive ends. But concessional loans from the World Bank to the gov
ernments of developing nations have increased in recent decades
(and continue to increase), while the productivity of government
investment has decreased. Free-market rhetoric aside, there is no
getting around the inherent structural failure of the World Bank:
according to its charter, it must lend to governments, and aid to
governments will always result in investment by governments.
Thus, World Bank loans designed to "underpin policy dialogues
on market-oriented reform" are used by governments to expand
or initiate other government investment schemes.
Global Privatization Trend Catches Up with World Bank
In 1991 the U. s. Department of the Treasury proposed a revision
to the World Bank's charter that would have allowed it to extend
fully half of its loans to the private sector by 1995. Treasury under
secretary David Mulford explained before the Senate Foreign Rela
tions Committee that the reform was necessary, lest the bank be
left without a role to play as its borrower nations increasingly
privatize their state firms.
Indeed, privatization efforts in developing countries are extend
ing even into infrastructure-long considered a "public good" that
must be delivered by government, and an important sector of World
Bank lending since its founding. From 1990 to 1991, 12 nations,
induding Mexico, Venezuela, Argentina, Guyana, and Jamaica,
sold part or all of their telecommunications systems. In 1992 Malay
sia, Singapore, Argentina, and Venezuela were moving ahead with
plans to privatize their postal services; and Argentina, Malaysia,
and Thailand had either embarked on railway privatizations or had
new, privately financed railway systems under way. Also in 1992
the privatization of ports was completed or under way in Argentina,
Mexico, Panama, Venezuela, Brazil, Malaysia, and Singapore; and
private tollways were initiated in Mexico, Colombia, Venezuela,
Argentina, Malaysia, Hong Kong, China, Hungary, Poland, and
Czechoslovakia. 4
The Treasury abandoned its proposal barely three months after
making it-in the face of stiff opposition from the World Bank itself
4See Reason Foundation, Privatization IJJZ. Sixth Annual Report on Privatization
(Los Angeles: Reason Foundation, 1992).
315
MARKET LIBERALISM
and lack of support from any other major member of the bank.
The suggested reform was misguided in any case, since the World
Bank has for decades had a record of botched lending for private
enterprise. Consequently, the U. S. administration should not con
fine itself to proposing to "privatize" the lending side of the World
Bank. It should propose to privatize the bank's funding side as well.
Since the 1970s the World Bank has lent more than $30 billion
to private-sector borrowers. But because its charter permits it to lend
only to governments, it has had to create lending intermediaries
development finance institutions (DFIs)-run by local govern
ments, to relend World Bank funds to private borrowers. During
the rid-1980s World Bank officials began documenting the sorry
state of its DFIs. A 1985 report concluded, "Few DFIs have become
financially viable, autonomous institutions capable of mobilizing
resources from commercial markets at hore or abroad. " Another
report, issued in 1989, found that an average of 50 percent of DFI
loans worldwide were in arrears. That report concluded:
It is clear [that DFIs] have damaged financial systems . . . .
Acquiring subsidized credit could sometimes add more to
profits than producing goods . . . .
The ability to borrow at cheap rates encouraged less pro
ductive investment . . . . DFIs, by encouraging firms to bor
row from [government-run] banks, have impeded the devel
opment of capital markets . . . . Equity finance is a more
appropriate way to finance risky ventures than bank loans.
If governments establish the conditions necessary for equity
finance, intervention will not be necessary. 5
The 1991 Treasury proposal was an attempt to move beyond the
discredited DFI model by having the World Bank lend directly to
the private sector. The proposal would have entailed not only a
renegotiation of the World Bank's charter, but a total reconfigura
tion of the complex dynamics that allow the World Bank to combine
donor government guarantees (of the money it borrows in interna
tional markets) with borrower government guarantees (when it
lends that money in developing nations) to maintain its AAA credit
S
Worid Bank, World Development Report I JbJ. Financial Systems and Development
(Washington: World Bank, 1989), pp. 58-60.
316
The World Bank and the IMF
rating and keep the whole exercise rolling. It would be just as easy,
and a far more sensible reform, to privatize the World Bank entirely.
Privatize the World Bank
U. S. taxpayers support the World Bank with billions of dollars
of unfunded guarantees in the same way they unwittingly backed
the savings-and-Ioan insurance fund. The World Bank raises most
of the money it lends by issuing bonds in international capital
markets. Each year the bank floats about $12 billion in new bond
issues supported by about $12 billion in new unfunded "callable
capital" pledges from the United States and other industrial
nations. Privatizing the fund-raising side of the World Bank would
mean cutting it loose from U. S. taxpayers' annual cash infusions
and their $30 billion in accumulated guarantees.
Is that a pie-in-the-sky scenario? Not if the World Bank would
begin to distribute some of its annual net earnings of around $1
billion to its shareholder governments (rather than retaining the
earnings) . Once a track record of declaring and delivering dividends
was established, the bank's member governments could credibly
craft a plan to privatize the bank by selling its shares in the private
marketplace.
An alternative privatization scenario-which could be called Plan
B in the event that a public offering flopped because of investor
distrust of the health of the bank's loan portfolio-was proposed
by former Treasury official Paul Craig Roberts in the Wall Street
Journal in 1989. The World Bank would swap all its outstanding
loans for equity in enterprises in the borrower nations, then resell
those equity holdings to private investors, domestic or foreign. The
funds raised from the sale of equity would be used to redeem
outstanding World Bank bonds. To the extent that the World Bank
could not fully retire all its outstanding bonds with the funds raised,
the rich member countries would assume the liability by exchanging
the residual bonds for their own government bonds. Thus, the
scheme might involve some further expenditures on the part of
the industrial nations, but it would be worth it to clear away what
Roberts rightly termed the "entrenched institutional debris" of the
World Bank.
The Resilient IMF: A Brief Review
The IMF was established in 1944, under a system of fixed
exchange rates, as a mechanism for the international conversion
317
MARKET LIBERALISM
of all members' currencies-in effect, by establishing the U. S. dollar
as the medium of international exchange. In short, the IMF served
as a mediator between central banks attempting to maintain fixed
par values for their currencies. The essential objective of the IMF
was the revival and expansion of international trade through the
promotion of exchange stability and the elimination of the destruc
tive exchange practices (competitive devaluations) that had inhib
ited trade before World War II.
In 1971 President Nixon ended the U. S. Treasury's commitment
to convert U. S. dollars into gold, and a system of floating exchange
rates followed. That development stripped the IMF of its reason
for being. A country with a balance-of-payment deficit could reduce
demand at home, finance the deficit on the growing international
capital market, or simply let its currency depreciate. Still, no one
proposed closing down the IMF. Instead, the IMP's charter was
revised to legitimize the new floating rate system. In the 1970s the
institution defined for itself two entirely new missions: easing the
adjustment for countries with balance-of-payment deficits and pro
viding financing on especially easy terms to low-income countries
through three new credit facilities. New IMP loans increased sixfold
by 1974.
When the Mexican government defaulted on its foreign loans in
1982, the unprecedented bailout package devised by U. S. Federal
Reserve chairman Paul Volcker and IMF managing director Jacques
de Larosierre thrust the IMF to the center of a U. S. -led strategy to
mobilize new loans to keep developing nations from defaulting on
old loans. Thus, in 1982 the IMP's primary mission became that of
"managing" developing nations' foreign debt "crises. " The result
has been unprecedented wide and protracted IMF intervention
throughout the world.
In 1990, with nearly 50 nations under IMF lending programs,
George Bush pledged another $12 billion from the United States
to help the IMF further expand its lending. In late 1992 Congress
approved the funds, which represented the U. S. share of a 50
percent boost in IMF resources-from $130 billion to $195 billion.
"Failure of the United States to support [the $12 billion for the IMF]
would seriously erode the effectiveness and credibility of the IMP, "
Treasury Secretary Nicholas Brady told a Senate panel while pro
moting congressional approval of the U. s. infusion. As evidence
318
The World Bank and the IMF
of "effectiveness and credibility," however, Brady spoke only of
the IMF's resource transfers, noting more than once that the IMF
was "providing vast amounts of resources in Eastern Europe, Latin
America, Africa and Asia. "
As Cato Institute senior fellow Doug Bandow argues, the best test
of the effectiveness of the IMF is whether any troubled developing
nation has ever " graduated" from reliance on emergency IMF loans.
Success stories seem to be nonexistent. South Korea borrowed from
the IMF once, but that was in 1974 after its economic miracle was
well under way.
The IMF has been subsidizing the world's economic basket cases
for years, without any apparent success. Egypt has not been off
the IMF dole since 1959. Ghana took its first loans in 1962 and
remained a borrower for all but three months over the next 27
years. India was one of the IMP's first loan recipients and, except
for short intervals, has been on an IMF program for more than 40
years. Mali has been an IMF borrower for more than 25 years. Since
1959 the Sudan has been in debt to the IMF in all but two years.
Bangladesh, Uganda, Zaire, and Zambia all started borrowing in
the early 1970s and have yet to stop.6
Failed Recipe for Devaluation and Austerity
A track record like that prompts the question: what is the nature
and effect of the package of economic policy reforms, or "condition
ality," that accompanies most IMF loans?? The IMF never makes
public the "letter of intent" signed by a borrower nation, which
outlines the conditionality to which the nation agrees. But elements
of standard IMF conditionality programs are frequently leaked
usually to journalists reporting from the borrowing countries. From
such reports, it is clear that IMF conditionality typically includes
an anti-growth package of currency devaluation, new taxes or tax
rate hikes, and sometimes even hikes in import taxes. In general,
IMF programs concentrate on setting macroeconomic targets. The
most central tenet is that a nation's trade or current account, or
both, should never be in deficit.
6"The IMP: Foreign Aid Addiction, " National Reie, June 8, 1992, p. 16.
7This section is excerpted from Alan Reynolds, "The IMP's Destructive Recipe
of Devaluation and Austerity," Hudson Institute, May 1992, which the author
helped to prepare.
319
MARKET LIBERLISM
That doctrine is a discredited holdover from 1 7th-century mercan
tilism. As a rule, world capital flows toward superior investment
opportunities. As the Swiss economist Jurg Niehans put it, "Coun
tries are debtors if their investment opportunities exceed their
wealth and are creditors when their wealth exceeds their invest
ment opportunities. " A deficit on current account, with one major
exception, simply means that domestic investment opportunities
are superior to those elsewhere, which causes capital to remain in
the country and attracts foreign capital as well. (The exception
occurs when governments borrow from institutions such as the
IMF; such borrowing is motivated by considerations other than
profitable production and thus does not represent superior invest
ment opportunities. )
Developing countries can clearly benefit by exploiting investment
opportunities beyond those that can be financed by their own accu
mulations of wealth. Therefore, it is not inherently sinful for grow
ing economies to remain debtor nations-that is, run current
account deficits-for many years, as Japan and South Korea did.
If current-account deficits are financed by voluntary, private capital
inflows, they reflect improved opportunities for profitable invest
ment and production and make improved production possible (for
example, by financing imports of high-technology equipment) .
Hudson Institute economist Alan Reynolds argues that all
reforms that have been truly successful in launching a major surge
in economic activity and wealth have been accompanied by at least
a decade of current-account deficits. For example, from 1976 to
1985 Chile had an average current-account deficit of 7 percent;
Singapore's deficit was 6. 6 percent; Thailand's, 5. 3 percent; South
Korea's, 3. 3 percent; and Colombia's 2. 5 percent. s
With today's nearly fully integrated global capital market, it is
quite possible to finance new capital projects and any related cur
rent-account deficits with private equity and private debt from both
domestic and foreign sources (as opposed to the public debts repre
sented by IMF, World Bank, and commercial bank loans to govern
ments). To do that requires combining an attractive tax, regulatory,
and monetary environment with greater development of a nation's
own capital market.
8
Ibid. , Q. 18.
320
The World Bank and the IMF
Encouraging Tax Hikes Still Common
The IMP's devaluation theory, then, is closely related to its auster
ity theory, which holds that nations should close budget deficits
at any cost. According to the IMP's model, fiscal defcits cause
monetary expansion, which in turn causes a deterioration in the
balance of payments. "Curing" current-account deficits, then,
requires addressing budget deficits. That is where IMF prescrip
tions for new or higher taxes, or both, come into play.
IMF officials have long maintained that they merely set a target
for a nation's budget deficit and do not impose conditionality,
explicit or implicit, regarding whether the deficit is to be reduced
by raising taxes or by cutting spending-or the specific tax and
spending measures involved. Governments, however, usually do
not expect to satisfy powerful political constituencies by cutting
spending on big-ticket, money-losing items such as civil service
rolls and operating subsidies to state enterprises. Therefore, nations
on IMF programs have commonly imposed new taxes or raised tax
rates, or both, to meet their deficit-reduction targets. Nations also
commonly increase import tariffs-not only in pursuit of added
revenues but also to reinforce the currency devaluation's aim of
making imports more expensive (and exports less expensive) and
thereby manipulating a trade surplus.
In addition, notwithstanding the IMP's insistence that it merely
sets deficit-reduction targets, accounts of IMF programs in the inter
national financial press regularly link the institution to new or
higher taxes: In January 1991 the Philippines bowed to IMF pressure
and instituted a 9 percent supplemental levy on imports as a condi
tion for a new IMF loan. 9 In March 1991 India instituted a new
taxlike restriction designed to cut imports by 10 to 15 percent. A
year later imports had fallen by 17. 5 percent; but exports had fallen
by 6 percent, chiefly as a result of the import restriction, which
made raw materials, components, and capital goods scarce. Subse
quently, Indian economists explained that the economy was
plagued by an import-cut-induced recession. 10
9Greg Hutchinson, "Philippines Austerity Awaits IMF Seal of Approval," Financial
Times, February 20, 1991, p. 4.
10K. K. Sharma, "Big Fall in India's Trade Deficit," Financial Times, January 15,
1992, p. 4.
321
MARKET LIBERALISM
In the summer of 1991 Business Latin America reported that
in Argentina the IMP "seeks to boost the country's fiscal surplus
by raising the value-added tax, reintroducing export taxes and
increasing fuel taxes";
in Honduras "tax hikes necessitated by the [IMF] program are
generating serious labor and social unrest"; and
in Peru taxes "will be hiked sharply in an effort to narrow the
deficit to the IMF-mandated target. "l l
The IMP' s preoccupation with setting macroeconomic targets
leads to a bias against structural, microeconomic reforms. If the
governments of developing countries are to create the conditions
necessary for those countries to prosper, they will have to adopt
intelligent, market-oriented policies. IMF loans and bad advice
reduce the likelihood that recipient countries will make urgently
needed changes. Whatever its intentions, the IMP's actions only
reduce the chances that Third World nations will emerge from
poverty. Now that the statist vision of centralized economic plan
ning is in retreat throughout the world, it is more apparent than
ever that new and expanded missions for the IMF cannot be justified
and that the organization should be retired.
Conclusion
Czech prime minister VacIav Klaus notes correctly that "reform
begins and ends at home and that the role of external factors is
relatively small. " Further, he cites several external factors that have
a positive impact:
"the rapidly growing fow of visitors (both tourists and business
men) from abroad, who bring into the country market-oriented
attitudes, habits, and experience;
"the international trade of goods and services which undermines
the long-prevailing atmosphere of semiautarchic centrally
planned economies . . . and which brings into the transforming
country real competition and previously nonavailable world stan
dards; and
IlJssues of June 24, June 10, and July 15, 1991, respectvely.
322
The World Bank and the IMF
"foreign real investment, provided the country is in a situation
where property rights are already clearly defined and reasonably
protected. "1
2
Such international exchanges require neither the International
Monetary Fund nor the World Bank. In 1990, the most recent year
for which figures are available, inflows of foreign direct investment
to developing nations reached $32 billion, sharply reversing a
decline in the late 1970s and 1980s. Those nations that offer a
dynamic and secure investment climate-such as the Asian tigers,
Chile, and Mexico-are attracting ever larger inflows from the
world's private capital market.
The IMF and World Bank are discredited remnants of the past half
century's global experiment with top-down government economic
planning. Both institutions have fostered statism and dependence,
with enormously destructive results. They should be abolished, and
the private capital from Western nations that they absorb should be
freed. Its owners would then be able to seek out the best investment
opportunities throughout the developing world.
12Vaclav Klaus, "The Relative Role of Domestic vs. External Factors in the Integra
tion of Former Communist Lands into the World Economy," Speech before the
Mont Pelerin Society, August 31, 1992, Vancouver, Canada, mimeographed, p. 3.
Emphasis in original.
323
1J. Ending Washington's International
War on Drugs
Ian Vasquez
During the past decade, Washington has steadily intensified its
international campaign against illegal drugs. The United States has
increased spending on international narcotics control by more than
800 percent, and total federal expenditures on the drug war have
risen by about 600 percent, soaring to $1 1 . 9 billion in 1992. 1 During
the Bush administration alone, federal spending for the war on
drugs rose by an unprecedented $5. 3 billion.
In its efforts to curtail the supply of narcotics entering the country
from abroad, Washington has used a series of trade and aid sanc
tions and rewards to coerce drug-source nations to enlist in its
crusade. u. s. pressure and attention have been focused mainly
on Latin America, in particular the Andean region, source of the
majority of cocaine that reaches the United States. Unfortunately,
U. S. policy toward those countries ignores basic economic princi
ples and national political realities. As a result, the war on drugs
in Latin America is producing political instability and economic
disruption, posing a threat to the fragile democracies there. The
region's leaders are put in the awkward, if not impossible, position
of trying to satisfy conflicting U. S. and domestic agendas, while
anti-American sentiment grows. Thus, what many Latin American
nations consider primarily a U. S. problem has increasingly become
their own.
Anemic Results
Progress in the supply-side anti-narcotics battle has been less
than impressive, though official rhetoric would suggest otherwise.
I Lawrence J. Smith, "The US Role in the International War on Drugs, " Christian
Science Monitor, May 12, 1992, Q.20; and White House, National Drug Control Strategy:
A Nation Responds to Drug Use, January 1992, Q. J4J .
325
MARKET LIBERALISM
Two main components of Washington's foreign war on drugs are
interdiction of trafficking networks and eradication of illegal crops.
As evidence of major advances in those areas, the State Department
has stressed increased cocaine seizures and reductions in the culti
vation of coca during 1991. Indeed, total land dedicated to coca
cultivation in the Andean region fell from 211, 820 hectares in 1990
to 206, 240 in 1991 .
2
But those figures do not constitute a threat to
the illegal drug industry, much less represent "significant damage
on the cocaine trafficking organizations" as suggested by the State
Department's 1992 International Narcotics Control Strateg Report .
3
A
paltry decline of less than 3 percent in the overall land area devoted
to the cultivation of coca is unlikely to discourage most individuals
involved in the multi-billion-dollar cocaine trade.
Even the official figures presented in the State Department report
indicate that acreage eradicated, both in absolute terms and as a
percentage of total cropland planted in coca, has declined, though
modestly, since 1990. And in the case of Peru, the world's largest
producer of raw coca, U. S. government data show that no crops
were eradicated for two years in a row. Although coca cultivation
in Peru has leveled off in the past few years, U. S. and Peruvian
officials admit that the leelig is largely due to the spread of a
fungus detrimental to coca plants, not to government efforts to
control the illegal crop.
The eradication numbers may not be reliable in any case. The
U. s. -coordinated anti-drug effort provides source countries with
strong incentives to overstate the effectiveness of eradication pro
grams. U. s. foreign assistance is more likely to be channeled to
countries that are able to cite positive results of their anti-narcotics
efforts. Conversely, countries whose eradication programs are not
"successful" may be charged with lack of cooperation and conse
quently risk the suspension of aid and the application of trade
sanctions.
The lack of progress in its supply-side campaign has led the U. S.
government to assert that "national will" and commitment of drug
source countries are more important measures of success than erad
ication figures or other quantitative variables. By introducing the
2
U. S. Department of State, International Narcotics Control Strategy Report, March
1992, p. 27.
3Ibi d. , p. 5.
326
International War on Drugs
concept of national will, Washington has not only attempted to
gloss over the drug war's anemic results; it has also created an
additional means, both ambiguous and arbitrary, of judging the
cooperation of drug-source nations.
Emphasis on eradication efforts, total land devoted to coca culti
vation, and national will is misplaced, however. Far more relevant,
and more damning, are figures representing actual coca leaf produc
tion. Those figures indicate that net production of the leaf has
actually increased every year since 1988-from 273,700 metric tons
that year to an estimated 337, 100 metric tons in 1992. 4 It should
not be surprising then that cocaine production and importation into
the United States have also increased every year since President
Bush took office. 5
That there is a growing amount of cocaine entering this country
is an indictment not only of eradication efforts but also of the
interdiction component of the drug war. In fact, only 5 to 15 percent
of all intended drug imports are seized by U. S. authorities.
Although the amounts captured may raise drug traffickers' operat
ing costs somewhat, the U. s. price range for a kilogram of cocaine
has not risen over the past few years. Indeed, the price range has
dropped in major cities such as Los Angeles, Miami, Chicago, and
New York.6 Thus, Washington's interdiction strategy has clearly
failed to achieve its primary goal of raising cocaine prices paid by
. L. drug users.
The failure of interdiction programs and source-country efforts
to increase U. S. prices, and thereby effect a reduction in demand,
refects something more than ineffectiveness. Overseas counternar
co tics strategy suffers from a fundamental flaw: it relates domestic
demand for cocaine to supply reductions in drug-producing coun
tries. Because of the price structure of the drug trade, however,
that relationship is quite flimsy. The astronomically high profits of
the illegal industry ensure that any losses caused by supply-reduc
tion programs will have little impact on the traffickers' cost of
doing business. As a study by the RAND Corporation indicates,
smuggling expenses represent only 10 percent of the retail value
4
Ibi d. , p. 28.
SOrug Polic Foundation, The Bush Drug War Record, September 5, 1992, p. I I .
6Ibid.
327
MARKET LIBERALISM
of cocaine. That is, the price of the drug substantially appreciates
only after it enters the United States. That means that traffickers
have every incentive to continue smuggling cocaine despite the
fact that up to 15 percent of their product may be seized. Even a
highly improbable 50 percent reduction in the amount of South
American cocaine that enters the United States would increase the
final price of the drug by only about 5 percent-leaving consump
tion mostly unaffected.
The anemic results of Washington's anti-narcotics efforts in the
Andean countries should hardly excite even the most avid drug
warriors. The State Department's claim that it "has registered its
most important gains in confronting the cocaine trade"8 serves as
an appropriate and sobering indicator of how much success the
international war on drugs has had in general. Nevertheless, official
declarations of progress continue while signs of policy change or
reevaluation seem to be nonexistent. That trend is particularly wor
risome given the severe economic, political, and social disruptions
that the international anti-drug strategy causes in drug-source
nations.
Coercion by Consent
Washington emphasizes the cooperation of drug-source nations
as essential to its efforts to reduce the supply of illicit narcotics.
Over the years, the United States has employed a combination of
foreign aid benefits for countries deemed cooperative in those
efforts and the threat of economic sanctions against nations consid
ered uncooperative. U. S. financial assistance to Latin America
increased significantly with the Bush administration's 1989 Andean
Initiative. Under that program, $2. 2 billion in economic and military
aid is to be disbursed to South American drug-source nations over
a period of five years.
Attention paid to the hemispheric drug war was further escalated
by the much publicized drug summit of February 1990 in Cartagena,
7Peter Reuter, Sealing the Borders: The Efects of Increased
M
ilitar Participation in Drug
Interdiction (Santa Monica: RAND Corporation, 1988); cited in General Accounting
Office, "Drug Control: Impact of DoD's Detection and Monitoring on Cocaine
Flows," September 19, 1991, pp. 26-27; and Mathea Falco, "Foreign Drugs, Foreign
Wars," Daedalus 121, no. 3 (Summer 1992): 7-8.
BU. s. Department of State, p. 5.
328
International War on Drugs
Colombia. That meeting, attended by Bush and the presidents of
Peru, Bolivia, and Colombia, resulted in the formation of the so
called anti-drug cartel. Though a renewed commitment to fight
the drug trade through a comprehensive multilateral strategy was
expressed by all four nations, the summit did not produce major
changes in the direction of anti-narcotics policy. Instead, Andean
leaders tried to exploit Washington's desire to escalate the drug
war by seeking pledges of increased economic assistance in return
for their promise to increase efforts to discourage coca cultivation,
disrupt drug traffcking, and improve control over chemicals used
in the production of illicit drugs. Washington agreed to reduce
domestic demand for drugs, increase assistance for supply-reduc
tion and interdiction programs, and develop alternative sources of
income for coca growers.
Although financial assistance to Andean countries has grown
consiqerably since 1989, continuing disputes between the United
States and its Latin American "partners" over a variety of drug
war issues show that neither the Cartagena Summit nor the Andean
Initiative has significantly harmonized the priorities of the nations
involved. Peru, for example, has long been critical of the U. S.
funded counternarcotics programs there. Both former president
Alan Garda and his successor, Alberto Fujimori, expressed dissatis
faction with the amount of economic aid provided by the United
States. U. S. -Peruvian relations became especially tense in Septem
ber 1990 when Fujimori refused to sign a $35. 5 million military aid
agreement and insisted that more funding for crop-substitution
programs be made available.
Other examples of friction between Washington and the mem
bers of its anti-drug cartel include recurring disagreements with
Colombia about the extradition of suspected traffickers and U. S.
demands that the Bolivian and Peruvian governments dismiss offi
cials who are not popular with the United States. Though Andean
countries generally yield to U. S. pressure (as the Fujimori regime
eventually did), U. S. and source-country priorities continue to
differ.
While offers of U. S. economic assistance are used to entice Latin
American governments into enlisting in the U. S. -directed drug war,
perhaps a more effective means of "convincing" drug-producing
nations to cooperate is the threat of economic sanctions. The U. S.
329
MARKET LIBERALISM
Anti-Drug Abuse Acts of 1986 and 1988 are designed to do just
that. The acts make U. S. foreign aid and trade benefits contingent
on the participation of drug-source countries (drug-producing or
drug-transiting countries) in eradication and interdiction programs.
The annual process of "certification" requires the U. s. president
to determine whether the government of a source nation has ade
quately cooperated in those supply-reduction efforts.
Certification of cooperation compels the president to consider
whether foreign government actions have resulted in the maximum
possible reduction in the production of illegal drugs. If the president
does not certify a major drug-source country, or if Congress disap
proves his certification, mandatory sanctions are automatically
imposed, and the application of other sanctions is left to the discre
tion of the president. The mandatory sanctions include
suspension of 50 percent of U. S. assistance (except humanitarian
and international narcotics control aid) for the current fiscal year;
suspension of all U. S. assistance (again except humanitarian and
international narcotics control aid) during subsequent fiscal
years;
voting against multilateral development bank loans to an offend-
ing country; and
denial of a sugar quota.
Sanctions that may be imposed at the discretion of the president
include
denial of preferential tariff treatment for the exports of the non
certified country under the Generalized System of Preferences
and the Caribbean Basin Initiative;
duty increases of as much as 50 percent on exports to the United
States;
limits on air transportation and traffic between the United States
and the noncertified country; and
the end of U. S. participation in any preclearance customs
arrangements with the noncertified country. 9
9
See Raphael Francis Perl, "Congress, International Narcotics Policy, and the
Anti-Drug Abuse Act of 1988," Journal of Inter-American Studies and World Afairs 30
(Summer-Fall 1988): 25-26.
330
International War on Drugs
The combination of mandatory and discretionary sanctions pro
vides the U. S. government a powerful economic lever with which
to seek the compliance of drug-source nations. Although the with
drawal of multilateral and bilateral development aid would actually
be beneficial for recipient nations-especially in light of the poor
record of foreign assistance programs and Latin America's trend
toward economic liberalization-it should not be surprising that
source countries want to avoid any short-term disruptions that
would be caused by sudden suspensions of aid. Trade sanctions
represent an especially great threat to the economies of drug-pro
ducing nations, many of which depend heavily on access to the
U. S. market. Restrictions on trade with Colombia, 46 percent of
whose exports go to the United States, would cripple that country's
economy. Similarly, 17 percent of Bolivia's exports are destined
for the United States, and Peru's export figure is 22 percent. The
prospect of losing foreign aid and the possibility of facing trade
sanctions offer powerful incentives for drug-source countries to
participate in anti-drug efforts even when they have grave misgiv
ings about the wisdom of the policy.
Source Country Gestures and Economic Reality
Commitments from source nations to destroy the drug trade are
tempered by the fact that the narcotics industry represents a major
pillar of those countries' economies. The cocaine business in South
America provides direct employment for 500, 000 to 1 million peo
ple. In Bolivia the illicit drug trade employs 20 percent of the work
ing population and provides $700 million in export revenues
l
O com
pared to the approximately $1 billion earned from legal exports. In
Peru cocaine accounts for at least 35 to 45 percent of export earnings
and its production employs about 15 percent of the national work
forceY Moreover, the Peruvian central bank takes in $ million to
$6 million in narcodollars every day. The cocaine industry is by far
Peru's largest generator of foreign exchange earnings. According
to one expert, hard currency entering Peru through the illegitimate
channels of the drug trade equals 20 percent of that nation's GNP,
IO"Doped, " The Economist, August 29, 1992, p. 36.
I IStephen J. Trujillo, "Peru's Maoist Drug Dealers, " New York Times, April 8, 1992,
p. A24; and Peter R. Andreas et al. , "Dead-End Drug Wars," Foreign Policy 85
(Winter 1991-92): 1 13.
331
MARKET LIBERALISM
while Peru's largest legal exp'ort, copper, produces foreign
exchange earnings of only 1 . 4 percent of GNP. 12 The illicit drug
trade is also of vital importance to the economy of Colombia. Esti
mates of annual income generated by the cocaine industry generally
range from $4 billion to $5 billion, whereas legal exports generate
about $7 billion. One expert estimates that revenues from the nar
cotics business equal about 36 percent of GNP and represent Colom
bia's largest source of foreign income.
It IS naive to think that leaders of drug-source nations would
seriously act to shut down an industry central to their economies.
Bolivian president Jaime Paz Zamora, for instance, has compared
the effect of eradicating his country's coca business to that of putting
50 million Americans out of work. 14 Yet U. S. pressure to close down
the illicit drug industry continues despite the obvious incentives
for source nations to comply with counternarcotics strategy in only
a perfunctory manner.
In light of the relatively high profits that illegal cultivation of
coca (and to a lesser extent, marijuana) can offer, U. S. and Latin
American official s have tried to produce legal alternatives that
growers might consider economically appealing. Thus, the govern
ments involved have attempted to attack the drg industry in ways
that might be considered less destructive. Crop-substitution pro
grams are the most significant of those efforts.
An assortment of crops, including cotton, tea, cocoa, bananas,
coffee, (oil) palms, and corn, has been proposed as substitutes for
drug plants. Here again, economic realities seriously hamper the
chances of reducing the supplies of coca or marijuana at their
source. Both drug plants can be grown in areas and under condi
tions in which alternative crops cannot easily be cultivated. The
Upper Huallaga Valley in Peru and Bolivia' s Chapare region, two
areas in which much South American coca is grown, are good
examples. The remoteness and poor soil quality of those regions
render substitution efforts economically unfeasible. Still more
12Gabriela Tarazona-Sevillano and John B. Reuter, Sendero Luminoso and the Threat
of Narcoterrorism (New York: Praeger, 1990), p. 1 13.
13Brian Freemantle, The Fix: Inside the World Drug Trade (New York: Tom Doherty
Associates, 1986), p. 211; cited in Scott B. MacDonald, Dancing on a Volcano: The
Ltin American Drug Trade (New York: Praeger, 1988), p. 45.
14Andreas et al., pp. 1 13-14.
332
International War on Drugs
important in considering the economic viability of legal crops is
the fact that peasants can earn up to 10 times more from planting
coca than they can from growing alternative crops. In addition,
coca can be harvested 18 months after planting, requires little care,
and can yield three to four harvests per year when mature. By
contrast, many legal crops require much attention and take four or
more years to yield returns.
Some substitution programs emphasize deregulation of agricul
ture in recognition that coca is traded in a free (though illegal)
market while legal crops are traded in overregulated markets.
Removing the bureaucratic and economic barriers to agricultural
production and trade should be welcomed and will do much to
simplify economic transactions in that sector. Nevertheless, crop
substitution programs insist on overlooking the economics underly
ing the cocaine industry. As long as drugs remain illegal in consum
ing countries-thus artificially raising their final price-and
demand for those drugs persists, the enormous profit potential
will provide a sufficient incentive for producers to supply market
demands. Only if the sale and consumption of drugs are legalized
in the United States and other narcotics-consuming countries will
the cultivation of alternative crops become economically feasible.
Nevertheless, the U. S. and source-nation governments provide
funds to coca farmers to encourage them to switch crops. The
perverse effect of promoting substitution in that way has already
been observed. Peasants often accept the money and continue culti
vating drug crops elsewhere. Thus, U. S. foreign aid has actually
subsidized the production of coca.
One of the most positive ways of encouraging legal agricultural
production would be to reduce U. S. trade barriers. Latin American
nations have long viewed U. s. protectionist policies as an impedi
ment to the creation of a healthy, legal agricultural sector. For
example, Peru's exports of cotton apparel and other textiles to the
United States have been severely limited by U. S. quotas in recent
years. 15 And although the 1991 Andean Trade Preference Act,
which provides duty-free treatment of imports from Colombia,
Ecuador, Peru, and Bolivia, is a step in the right direction, Andean
I
S
Melanie S. Tammen, "The Drug War vs. Land Reform in Peru," Cato Institute
Policy Analysis no. 156, July 10, 1991, p. 9.
333
MARKET LIBERALISM
leaders have reason not to be overenthused about its benefits. The
legislation denies duty-free treatment to many products, including
most textiles and apparel. Even official crop-substitution efforts are
hindered by U. S. industries' desire to protect their market shares.
A study by the General Accounting Office in October 1991 found,
for example, that the American Soybean Association was effective
in preventing U. S. assistance for growing soybeans in Bolivia as a
substitute for coca. 16 Colombia, too, has been frustrated by its inabil
ity to get Washington to lower its tariffs on cut flowers and coffee,
two of its major exports. Washington further complicated Colom
bia's efforts to promote legal exports by its 1990 decision to impose
additional countervailing duties on Colombian cut flowers.
The Disruption of Latin American Societies
U. S. counternarcotics strategy in Latin America is undermining
the region's democracies, causing societal disruptions, and produc
ing hostile anti-U. S. sentiments among native populations.
One of the greatest threats of the international drug war to the
stability of Latin American democracies has been the U. S. insistence
on greater participation by the military. Obvious examples of Wash
ington's desire to militarize the drug war include the 1989 U. S.
invasion of Panama, the deployment of battleships off the coast of
Colombia without that country's consent, and the construction of
military bases for drug operations in the Upper Huallaga Valley of
Peru. 17 Although the profile of the U. S. armed forces has been
lowered since those episodes, Washington still considers military
intervention in the drug war a high priority. In fact, u. s. military
aid to Andean nations has increased substantially, from $3 million
in 1988 to $203. 5 million during 1990 and 1991 Y
Although the military establishments of Andean countries do
not identify the drug industry as the number-one threat to national
J6Generai Accounting Office, "Drug Policy and Agriculture: U. S. Trade Impacts
of Alternative Crops to Andean Coca," October 1991.
J7Bruce Michael Bagley, Myths of Militarization: The Role of the Military in the War
on Drugs in the Americas (Coral Gables, Fla. : University of Miami North-South Center,
1990), p. 15.
J8White House, p. 1 69; Andreas et al . report that "the Andean region has now
replaced Central America as the leading recipient of U. S. military aid in the hemi
sphere" (p. 106).
334
International War on Drugs
security and cite counterinsurgency or the defense of national bor
ders as their primary missions, the drug war serves as a credible
pretext for increasing military involvement in domestic affairs. By
strengthening the armed forces of various Latin American nations,
U. s. aid promotes the traditional interventionist role of the military
in civil and economic affairs. Washington's attempt to apply a
military solution to what is primarily an economic problem threat
ens to weaken fragile democratic institutions and even reverse the
past decade's trend toward democratization.
Washington's policies have also sent the drug industry into areas
that might otherwise have remained unaffected by the business.
Eradication and interdiction campaigns simply force trafficking
organizations to move their operations to other locations. Thus,
drug operations spread to the central and lower parts of Peru's
Huallaga Valley when officials intensified their anti-narcotics efforts
in the Upper Huallaga. Similarly, when Colombia clamped down
on the Medellin cartel in 1989, the Cali cartel increased its market
share of cocaine from 30 to 70 percent in less than a year. 19 The
dispersal of the drug trade has led to a significant rise in drug
related activity in Brazil, Venezuela, Guatemala, Argentina, and
Suriname. That "push down, pop up" effect has also resulted in
a sharp increase in drug trafficking in Chile. Since Chile emerged
from dictatorship only a few years ago, the reluctance of Chilean
officials to involve the military in fighting the drug problem is
understandable.
Z
Another problem with U. S. counternarcotics strategy is that it
places drug-source governments in untenable positions and height
ens anti-U. S. sentiments. The Colombian government' s quarrels
with the United States over the extradition of drug traffickers illus
trate that point. Washington's demand that suspected traffickers
be extradited to the United States is highly unpopular with most
Colombians who view it as an expression of Yankee imperialism.
Rather than continue its bloody battle against the cartels, Colombia
has resisted U. S. pressure and, under President Cesar Gaviria, has
sought to recover the political and economiC stability the country
19Andreas et aL, p. 1I1.
20Sara Isaac, "Chile Wary of Growing Drug Trade," Orlando Sentinel, March 1,
1992, Q. G2.
335
MARKET LIBERALISM
had been losing. In 1991 Gaviria successfully convinced cartel lead
ers to surrender in exchange for reduced sentences, guarantees
against extradition, and other concessions. Although that move
was popular with Colombians, Washington was not fully satisfied.
Cartel leader Pablo Escobar's July 1992 escape from prison unde
niably confirmed Washington's suspicion that Colombia's criminal
j ustice system could be easily corrupted by the drug bosses. Never
theless, the use of U. S. military planes over the city of Medellin to
search for Escobar triggered renewed protests against U. S. viola
tions of national sovereignty. Although Gaviria defended the
flights, Colombians remained suspicious of U. S. motives. A June
1992 U. S. Supreme Court ruling that the United States could kidnap
suspects abroad and bring them to trial in the United States had not
been quickly forgotten. Colombians' suspicions gained credibility
when both Rep. Robert G. Torricelli (D-N.J . ) , chairman of the House
Subcommittee on Western Hemispheric Affairs, and Rep. Charles
E. Schumer (D-N. Y. ) , chairman of the House Subcommittee on
Crime and Criminal Justice, agreed that a U. s. expedition to capture
Escobar was "an option that has to be considered. "
2
1 Although
Washington has not taken such dramatic steps, those events are
indicative of the conflicting demands, of both their own citizenry
and the U. S. government, with which governments of drug-source
countries must contend.
Peru perhaps provides the best example of how Washington's
drug policy disrupts Latin American societies. As the U. S. -orches
trated war against coca steadily escalated in Peru's Upper Huallaga
Valley during the 1980s, the Shining Path guerrilla movement,
which had previously had a minimal presence there, gained control
of about 90 percent of the region. 2 The guerrillas have expanded
their base of popular support by exploiting the cocaleros' hostility
toward eradication programs. With over 200,000 Peruvian peasant
families directly dependant on coca cultivation for their livelihood,
eradication efforts play into the hands of the Shining Path, and
coca growers are not reluctant to accept the guerrillas' offers of
protection from drug enforcement officials.
21Joseph B. Treaster, "Frustration in Washington," Ne York Times, July 24, 192,
p. A9.
22Tammen, p. 14.
336
International War on Drugs
Anti-drug efforts have also produced a source of substantial
financial support for the Shining Path. As drug traffickers sought to
protect their businesses, they too entered a marriage of convenience
with the guerrillas. Estimates of annual income earned by the Shin
ing Path range from $15 million to $100 million. U. S. counternarcot
ics assistance actually creates the conditions under which the Shin
ing Path's services become necessary. That point has led Harvard
economist Robert J . Barro to conclude, "The U. S. government could
achieve pretty much the same results if it gave the aid money
directly to the terrorists. "2
Peruvian president Fujimori' s April 1992 abrogation of the consti
tution and military-backed suspension of democracy were largely
the results of factors created by Washington's war on drugs.
Although U. S. anti-narcotics assistance increased the militarization
of Peruvian society, the demise of democracy was due more to
Fujimori's attempt to more effectively fight the growing presence
of the Shining Path. Both the expanded role of the military in Peru's
domestic affairs and the increased economic and popular support
enjoyed by the Shining Path resulted from Washington's obsession
with fighting the drug problem at its source. Unfortunately for
Peru, its fedgling democracy was irreparably undermined.
Conclusion
Washington's international war on drugs has not only failed to
achieve its stated objectives; it has also caused severe economic,
political, and social disruptions in source nations. Increased efforts
to fight the drug war will only aggravate those conditions. The
worldwide, and especially the hemispheric, trend toward political
and economic liberalization should facilitate Washington's urgently
needed radical departure from its foreign drug policy of recent
years. The United States should recognize the economic realities
of its anti-narcotics campaign and end its futile experiment in prohi
bition. The legalization of drugs would bring an end to narcotics
related violence both in the United States and abroad by bringing
2Robert J. Barro, "To Avoid Repeats of Peru, Legalize Drugs," Wall Street Journal,
April 27, 1992, p. A14. The Defense Intelligence Agency estimates that Colombia's
largest guerrilla group, Fuerzs Armadas Revolucionarias de Colombia, eared up to
>million in 1988 through its involvement in the drug industry. See Charles Lane
et al. , "The Newest War," Newsweek, January 6, 1992, p. 22.
337
MARKET LIBERALISM
the drug industry into the legal framework of the market. In coun
tries such as Peru or Colombia, legalization would be the single
most powerful tool for undermining the legitimacy of guerrilla
groups because it would remove both economic and popular sup
port. Legalization would also reduce the enormous profits of the
drug trade, thus making the cultivation of alternative crops econom
ically viable.
Short of legalization, Washington should take the following
steps.
End the international war on drugs. Enlisting other countries to
fight what is primarily a U. S. domestic problem is poor foreign
policy. Theoretical and practical analyses of efforts to curtail drug
supplies at their source suggest that even impressive results in
those efforts would have little impact on domestic consumption.
Repeal legislation requiring the certification of drug-source coun
tries. That type of coercion has succeeded only in worsening
U. S. relations with drug-producing countries. It has not been
effective in getting source nations to implement policies that are
contrary to their best interests.
Substantially reduce trade protectionism and all stipulations that
trade privileges be tied to cooperation in the drug war. That step
would make legal export goods more appealing as alternatives
to the cultivation and production of illicit commodities. The estab
lishment of free-trade agreements with Latin American nations,
for example, would be a step in the right direction. Such agree
ments, however, must minimize both tariff and nontariff barriers.
338
ARTN
LCOLOGY
Zd. Global Warming: Facts vs. the
Popular Vision
Patrick J. Michaels
Virtually all scientists directly involved in research on climatic
change believe that the earth will undergo some warming as a
result of the increase in manmade emissions that absorb infrared
radia tion, or enhance the "greenhouse effect. "
However, within certain broad limits, how much the world warms
is irrelevant. The critical policy question is how the world will warm,
because the real effect of warming will be expressed by its regional
ity, seasonality, and distribution within the day-night cycle. There
are now several compelling lines of evidence that indicate that,
when those three factors are taken into account, the odds on the
earth' s experiencing an ecologically or economically disastrous
global warming, either in magnitude or in time, are long indeed.
Those findings are at considerable variance with what might be
referred to as the "Popular Vision" of global warming: a doubling of
carbon dioxide in the earth's atmosphere resulting in a temperature
increase of approximately 4C, a pronounced rise in sea level due
to the melting of major areas of land ice and thermal expansion of
water, and starvation and civil strife as the consequences of ecologi
cal chaos. !
Although proponents of the Popular Vision cite the Poli1ks
Sum1r of the recent report of the United Nations' Intergoveren
tal Panel on Climate Change (IPCq in support of their position,
2
the
IThat vision also appears in the refereed scientific literature; for example, R. Rind,
J. Goldberg, J. Hansen, et al . , "Potential Evaporation and the Likelihood of Future
Drought, Journal of Geophysical Research 95 (1990): 9983-100, projected a 1 ,00
percent increase in the frequency of severe drought by the year 2050.
2
United Nations' Intergovernmental Panel on Climate Change, Policymakers Sum
mar of the Scientifc Assessment of Climate Change (World Meteorological Organization,
UN Environmental Programme, 1990).
341
MARKET LIBERALISM
median range of the climate impacts suggested i the report as a
whole does not suggest that apocalyptic change is imminent.
The Popular Vision became prominent as the result of two syner
gistic events. The frst was the publication in the middle to late
1980s of several computer climate simulation models that predicted
that a doubling of atmospheric carbon dioxide would cause a mean
global warming of 4. 2C with winter warming of as much as 18C
in the north polar region. The second was the June 23, 1988, con
gressional testimony of James E. Hansen of the National Aeronau
tics and Space Administration that there was a "high degree of
cause and effect" between current temperatures and human green
house alterations. 3
Nowhere i n that testimony nor, to the best of my knowledge,
anywhere else did Hansen ever state that the anomalously warm
summer of 1988 in the United States was caused by an enhanced
greenhouse effect. Nonetheless, the press and the public concluded
otherwise: 70 percent of the respondents to a subsequent CNN poll
agreed with the statement that the 1988 drought was in fact caused
by "the greenhouse effect. " That response obviously reflects the
Popular Vision.
Trace Gas Concentrations and Temperature Histories
The earth naturally radiates infrared (low-energy) wavelengths,
which warm primarily the lower atmosphere. Several natural mole
cules, notably water and carbon dioxide, absorb the infrared radia
tion and redirect some of it back toward the earth's surface, which
has the effect of warming the lower levels of the atmosphere even
further. That is the greenhouse effect. The most significant green
house-enhancing chemical species whose concentrations have been
increased by human activity are, in descending order, carbon diox
ide (C0
2
), methane, nitrous oxide, and chlorofluorocarbons.
Because of the total change in atmospheric greenhouse gases,
the current effective CO
2
concentration is approximately 420 parts
per million (ppm), or 50 to 60 percent greater than the preindustrial
background range of 260 to 279 ppm. The IPCC corroborated that
view when it stated, "Greenhouse gases have increased since pre
industrial times . . . by an amount that is radiatively equivalent to
3James E. Hansen, Testimony before the U. S. Senate Committee on Energy and
Natural Resources, June 23, 1988.
342
about a 50 percent increase in carbon dioxide, " which gives a cur
rent effective value of 390 to 420 ppm. Thus, we have already
proceeded more than halfway to an effective doubling of the back
ground CO
2
concentration.
The computer models of the mid-1980s predicted that a 50 percent
increase in the relevant trace gases would lead to a warming of
more than 2. 0C, but the earth has actually warmed only about
half a degree in the last 100 years. 4 If greenhouse enhancement
invariably leads to an increase in surface temperature, why has
such an increase not been observed?
Ground-Based Temperature Records
Figure 20. 1 shows the ground-based temperature records of the
Northern and Southern Hemispheres from 1860 to the present. It
is clear that virtually all of the warming of the Northern Hemisphere
occurred before 1945 when the major industrial emissions of green
house-enhancing trace gases began. A linear trend through the
data since 1935 is statistically indistinguishable from zero. Figure
20. 2 shows the results of a trend analysis of global temperature
records. That figure also demonstrates that, in a statistical sense,
much of the observed warming had already taken place before 1945
and that there has been very little additional warming during the
period in which a majority of the emissions have occurred.
It should be noted that the longest standing ground-based tem
perature records are frequently biased by the effects of urbaniza
tion. Most of those records originated at 19th-century points of
commerce, which means that temperatures were initially recorded
at low-lying sites near rivers (sources of waterpower) . Those sites,
in which cold air pools at night, then showed artificial local warming
years later as the cities grew up around the weather stations. Thus,
those weather stations were initially shielded from a true climatic
warming, and then they exaggerated one that may not have oc
curred. The artifcial upward bias of temperature readings taken at
those stations has nothing to do with global or enhanced green
house warming. Rather, it has to do with the urban infrastructure
pavement that retains heat and buildings that impede ventilating
winds-that goes with growth of economic activity.
4
R. C. Balling, Jr. , and S. B. Idso, "100 Years of Global Warming?" Environmental
Conservation 17 (1990): 165.
343
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MARKET LIBERALISM
Figure 20.2
TRENDS IN GROUND-BASED TEMPERATURES SINCE 1920
0.50
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DURCL. Balling and Idso.
Figure 20.1 also shows that the watery Southern Hemisphere,
which should warm up least and slowest, in fact exhibits the more
"greenhouse-like" signal. The Southern Hemisphere should warm
least and slowest because 90 percent of it is covered by water, and
the highest 20 degrees of latitude are covered with ice that averages
thousands of feet thick. Liquid water requires a great deal more
energy to raise its temperature a given amount than does an equiva
lent land area. Further, the snow and ice fields of Antarctica and
vicinity, because of their inherent brightness, reflect more than
three-quarters of the incoming solar radiation. (For comparison,
the earth as a whole absorbs about 75 percent of the solar radiation
that reaches its surface.) It follows that temperature variations should
be much less in the southern half of the globe than they are in the
north.
Satellite Temperature Records
In 1979 the first of a series of weather satellites capable of measur
ing the temperature of the lower layer of the atmosphere with an
346
Global Warming
accuracy of J O.OloC was launched. Satellite coverage is virtually
global, and there can be no urban effect on satellite data. Figure
20.3 shows the temperatures recorded from satellite platforms for
both the Northern and the Southern Hemisphere.s
It is immediately apparent that there is no significant warming
trend in either hemisphere over the period of record. Moreover,
the fairly rapid warming between 1979 and the present that appears
in the ground-based data (Figure 20.1B) for the Southern Hemi
sphere is absent from the satellite data.
Thus, the temperature history of the planet supports neither the
Popular Vision nor the mid-1980s computer model forecasts of
global warming, either in pattern or in magnitude.
In his excellent book, The Heated Debate, Robert Balling, after
convincingly demonstrating that observed warming of the planet
has been far less than even the most conservative projections of the
early computer models,6 indicates that other industrial by-products,
such as sulfate aerosol (the chemical associated with acid rain),
may be in large part responsible for the observed lack of warming.
And several calculations indicate that the magnitude of compensa
tory cooling could be sufficient to have canceled all the expected
greenhouse warming to date.?
I do not believe that the hypothesis of sulfate cooling alone pro
vides a suffcient explanation of the observed data. Rather, there
is evidence that a concurrent increase in cloudiness, which is not
related to that aerosol and may, in fact, be a result of the greenhouse
enhancement itself, is mitigating the expected warming.
The Importance of Increasing Cloudiness
The importance of increasing cloudiness in a world with an
enhanced greenhouse effect cannot be overstated. Instead of the Pop
ular Vision of climate apocalypse, it would mean a pleasant world
with armer nights and little change i dayte temperatures.
SR. W. Spencer and J. R. Christy, "Precise Monitoring of Global Temperature
Trends from Satellite," ocicncc 247 (1990): 1558-62.
6Robert C. Balling, Jr., 1hcc1tc1Lc01tc(San Francisco: Pacific Research Institute,
1992).
7James L. Hansen and A. A. Lacis, "Sun and Dust versus Greenhouse Gases:
An Assessment of Their Relative Roles in Global Climate Change," N1turc346 (1990):
713-18.
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MARKET LIBERALISM
The Popular Vision of global warming entails three major threats:
(1) major reductions in crop yields, (2) a rapid and disastrous rise
in sea level caused by the melting of large areas of land ice, and
(3) ecological disequilibrium and loss of plant species. Each of those
threats is dramatically lessened if the greenhouse effect is mitigated
by increased cloudiness.
First, the primary cause of decreased agricultural yields is mois
ture stress, which can result in plant death, caused by lack of
sufficient water. Moisture stress is maximized during daytime,
especially on hot, sunny afternoons. If cloudiness increases, day
time temperature rises will be lessened, and moisture stress on
plants reduced. Further, temperatures reach their lowest values at
the end of clear winter nights. Increased cloudiness will warm those
nights and thus lengthen the growing season.
Second, large areas of high-latitude (polar) land ice-which must
melt in order to raise sea level significantly-melt during summer.
Yet all climate models, from the 1896 calculations of the Swedish
physicist Svante Arrhenius to the most recent version of the
Princeton computer model,8 confine the greatest warming to high
latitude winter, which coincides with night or twilight. If the pro
jected warming is modifieQ by an increase in cloudiness, the warm
ing in high-latitude summer could be canceled entirely.
An increase in air temperature over Greenland and Antarctica
would allow the moisture content of the atmosphere to increase
(the warmer the air, the more moisture it can hold) and result in
more precipitation. Because the temperature is so far below freez
ing, all the moisture would fall as snow. It may seem paradoxical,
but the way to make the world's two major ice fields grow is to
warm things up a bit. That, in fact, is what happened during the
last warm period, from 4, 000 to 7,000 years ago, according to studies
by Domack et al. and Miller and de Verna1. 9 Those authors argued
S. Manabe, R. J. Stouffer, M. 1. Spelman, and K. Bryan, "Transient Responses
of a Coupled Ocean-Atmosphere Model to Gradual Changes of Atmospheric CO
2
:
Part 1, Annual Mean Response," Journal of Climate 4 (191): 785-818.
. W. Domack, A. J. Jull, and S. Nakao, "Advance of East Antarctic Outlet
Glaciers during the Hypsithermal: Implications for the Volume State of the Antarctic
Ice-Sheet under Global Warming," Geolog 19 (1991): 1059-62; and G. H. Miller and
A. de Vernal, "Wil Greenhouse Warming Lead to Northern Hemisphere Ice-Sheet
Growth? Nature 355 (1992).
350
Global Warming
that warming would increase the ice volume and thus mitigate a
rise in sea level.
Indeed, satellite measurements indicate that snow cover in the
Norther Hemisphere increased by 18 percent between 1966 and the
late 1970s (see Figure 20.4). 10 In addition, the history of a worldwide
sample of mountain glaciers from 1964 to 1980 indicated that the
number of advancing glaciers increased dramatically and the number
of receding ones dropped by an equivalent value. Those trends did
not reverse in the first half of the 1980s (see Figure 20.5) . 11
The third negative prospect from climatic change-ecological dis
equilibrium and loss of species-is also profoundly affected by a
cloud-mitigated greenhouse, because the main cause of plant death
remains moisture stress, which occurs primarily during the day.
In addition, temperature changes of 5C in less than 50 years
values that exceed those of the direst computer model projections
have been common in the deglaciation of the last 18,000 years. 1
2
Those observed climatic changes, more rapid than the ones forecast,
were insufficient to promote ecological disaster.
Furthermore, throughout most of the past billion years, the con
centration of atmospheric CO
2
has been greater than it is today.
The same is true of the past 100 million years, which is the period
during which most of our food and fiber crops evolved. Only since
the beginning of the ice ages, some 5 million years ago, have tem
peratures and atmospheric CO2 fallen to current levels. When it
was really cold, at the height of the ice ages (the last advance
terminated only 18, 000 years ago), the concentration of CO
2
fell to
values that were within 100 million ppm of being unable to support
life. Thus, from the perspective of both geological and evolutionary
history, the atmosphere is currently impoverished in CO
2
, An addi
tional historical peculiarity is that gas bubbles trapped in Antarctic
ice tell us that the temperature dropped before the CO
2
concentration
changed, not after.
lODonald Wiesnet and Michael Matson, Environmental Data and Information Service
Report 1 1, no. 1 (U. s. Department of Commerce, 1980).
"Fred B. Wood, "Global Alpine Glacier Trends, 1960s to 1980s," Arctic and Alpine
Research 20 (1988): 404-13.
1
2
S. J. Lehmen and L D. Keigwin, "Sudden Changes in North Atlantic Circulation
during the Last Deglaciation," Nature 356 (1992): 747-62.
.
351
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Figure 20. 5
WOOD'S GLACIER HISTORY
1 970 1 975
Year
Evidence of Increasing Cloudiness
Global Warming
-Retreat
-Stationary
-Advance
Cloudiness increased 3. 5 percent across the United States
between 1950-68 and 1970-88Y Sunshine declined in Germany,
and the effect is greatest in the mountains. S. G. Warren and his
colleagues at the University of Washington have studied millions
of shipboard observations and found that global cloudiness has
increased (most notably in the Northern Herisphere) . 14
If those findings are correct and clouds-from any source, includ
ing sulfates-are increasing, the following should be observed:
1 . Nights should be warmed by both the increase in greenhouse
gases and the increase in cloudiness.
2. Daytime warming should be counteracted by cloud refectivity.
3. There should be a consequent decline in the daily temperature
range (difference between day and night).
4. The greatest warming (night effect) of clouds should occur on
(long) winter nights.
13J. K. Angell, "Variation in United States Cloudiness and Sunshine Duration
between 1950 and the Drought Year of 1988," Jourl of Climate 3 (1990): 296-306.
14S. G. Warren, C. J. Hahn, J. London, et aI. , "Global Distribution of Total Cloud
Cover and Cloud Type Amounts over the Ocean," U. S. Department of Energy,
1988.
353
MARKET LIBERALISM
5. The greatest counteraction of warming (day effect) should occur
on (long) summer days.
6. The least warming (night effect) should occur on (short) summer
nights.
7. The least cooling (day effect) should occur on (short) winter
days.
Each of those hypothetical effects is confirmed by the data.
Tom Karl and his colleagues have created a Historical Climate
Network (HCN) of 492 weather stations that are not affected by
urban growth.
I
S As shown in Figure 20.6A, daily high temperatures
across the United States have actually been declining since the early
1930s. The behavior of night temperatures (Figure 20. 6B) began to
change after 1 950. Since then, while day temperatures have
declined slightly, night temperatures have risen.
Figure 20. 7 details the change in daily temperature range (differ
ence between high and low) in Karl's HCN. It is apparent that the
difference began to decrease around 1950.
In addition to the U. S. HCN, Karl and colleagues examined day
and night temperatures, in another urbanization-adjusted record,
for mainland China and the former Soviet Union. I6 Although their
results are presented nationally, a composite table (Table 20. 1) dem
onstrates the ubiquitous nature of night warming and the lack of
day warming in the Northern Hemisphere. I7 Table 20. 1 is broken
down into seasons, and it is evident that summer daytime tempera
tures-the ones that must rise to create a climate catastrophe
have actually fallen across the hemisphere, while the lOa-year trend
shows that there has been a dramatic rise in winter night tempera
tures of 1 . 8C.
Since each of the six implicative hypotheses about temperature
and cloudiness is supported by the data, only the question of causa
tion remains: is the mitigation of the greenhouse effect a result of
an increase in sulfate aerosol, and therefore merely the screening
'5yom R. Karl, R. G. Baldwin, and M. G. Burgin, Historical Climatology Series 4-
(Asheville, N. C. : National Climatic Data Center, 1988).
''rom R. Karl, G. Kukla, V. N. Razuavayev, et al. , "Global Warming: Evidence
for Asymmetric Diurnal Temperature Change," Geophysical Research Letters 18 (1991):
2252-56.
'7Patrick J. Michaels and D. E. Stooksbury, "Global Warming: A Reduced Threat?"
Bulletin of the American Meteorological Society 73 (1992): 15-63-15-77.
354
Figure 20. 6
AVERAGE DAILY MAXIMUM (DAYTIME) AND MINIMUM
(NIGHIIME) TEMPERATURES IN KARL'S HISTORICAL
CLIMATE NETWORK
A: Maximum Temperatures
Z. D
Z

G
1 .D

1 .

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1 1

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355
MARKET LIBERLISM
Figure 20. 7
AVERAGE DAILY TEMPERATURE RANGE, OR THE DIFFERENCE
BETWEEN DAYTIME AND NIGHTIME TEMPERATURES, IN
KARL'S HISTORICAL CLIMATE NETWORK
1 D.
G
1 . D

&
1 .
W

1 O

1 O.
1 Z. D

1 1 1 1 Z 1 O 1 1 D 1 1 1 1 1
Year
Table 20. 1
AREA-WEIGHTED AGGREGATE TEMPERATURE TRENDS
[CIlOO YR) FOR THE UNITED STATES, CONTINENTAL CHINA,
AND THE FORMER SOVIET UNION
Mean Max. Mean Min.
Season {Da {Night}
Winter +0. 6 + 1 . 8
Summer

- 0. 4 +0. 4
Annual +0. 05 + 1 . 1
of one environmental problem (greenhouse warming) by another
(acid rain)? Or is it also a natural response of the atmosphere to
an enhancement of the greenhouse effect? If it is in part the latter,
in addition to the seven hypotheses noted above, which are verified
by the data, the following should also be observed:
1 . Night, day, and seasonal changes in temperatures recorded at
high-elevation land stations (such as those on mountaintops)
356
Global Warming
should be similar in character to those observed at low eleva
tions.
2. There should be disproportionate night warming in the Southern
as well as in the Northern Hemisphere.
Theoretical calculations all agree that surface warming should be
accompanied by some cooling of the upper layers of the atmo
sphere, and most computer models confine that cooling to regions
above the earth's active weather zone, or approximately 45,000 feet
in the midlatitudes. But J. K. Angell has demonstrated that cooling
has been observed from approximately 25,000 feet upward. That
altitude is easily within the active weather zone and, everything
else being equal, should result in increased cloudiness. Thus, the
natural atmospheric response to greenhouse enhancement may be
an increase in midlevel and high-level cloudiness.
Almost all sulfate aerosol-along with other particulates-tends
to be confned to the bottom 7,000 feet of the atmosphere. If the
cloud increases were primarily a result of sulfate aerosol, high
elevation stations should not show night warming (accentuated
in winter) and counteraction of daytime warming (especially in
summer) .
Figure 20. 8 shows maximum (day) and minimum (night) temper
atures for winter and summer from the Pic du Midi Observatory
in the French Pyrenees.
I
9 Pic du Midi is a particularly important
weather station inasmuch as the surrounding terrain is exceedingly
difficult, which minimizes human interference, and the station is
above timberline, which means that growing trees cannot artificially
warm the nights and cool the days. Perhaps most important, at
9,400 feet, it is above almost all the sulfate aerosol.
Yet its temperature record is similar to that of the low-elevation
stations detailed in Table 20. 1 . The rise in nighttime temperature
(for both summer and winter) is highly significant, as is the decline
in summer daytime temperature. The magnitude of those changes
is striking and clearly out of proportion to the minuscule amount
of sulfate aerosol residing at or above 9,400 feet. Thus, it would
18J .
g
Angell, "Variation in Global Tropospheric Temperature after Adjustment
for the EI Nino Infuence, 1958-89," Geophysical Research Letters 17 (1991): 1093-96.
19 A Bucher and J. Dessens, "Secular Trend of Surface Temperature at an Elevated
Observatory in the Pyrenees," Journal of Climate 4 (1991): 859-68.
357
Figure 20. 8
TEMPERATURES AT PIC DU MIDI OBSERVATORY
A: Winter Temperatures

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i ssa i saa i si a i saa i saa sa ssa i ssa i s:a i ssa i ssa
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Nightime
Global Warming
seem that mitigation of greenhouse warming is due primarily to
the high-altitude cooling noted by Angell .
Additional evidence for that conclusion is provided by P. A.
Jones's study that indicates that night warming in Australia (in the
Southern Hemisphere) also exceeds day warming, in this case by a
factor of 2 (0. 12Cldecade vs. 0. 06Cldecade) . 20 (Note that observed
warming is still far less than that projected by the computer mod
els. ) And Warren and his colleagues also found significant increases
in cirrus (high-altitude) clouds around Australia but no concomitant
increase in low-level stratocumulus, the type of cloud one would
expect to be enhanced by sulfate aerosol .
Second-Generation Computer Models
The first computer models were especially primitive in their han
dling of oceanic heat transfer, both within the ocean and to the
atmosphere, and in their formulation of clouds. Those models pre
dicted an average surface warming of 4. 2C after an effective dou
bling of atmospheric CO
2
.
The early models have been changed and improved. By using a
modified ice-water interaction within clouds, the United Kingdom
model projects a mean warming of 1 . 9C, considerably less than
its earlier projection of 5. 2C. The National Center for Atmospheric
Research (NCAR) model, which uses a coupled ocean and atmo
sphere, projects warming of 1 . 6C for 30 years after an "instanta
neous" doubling of CO
2
, compared to 3. 7C projected by an earlier
model with a more primitive ocean. A slightly different version
of that model, in which the greenhouse effect increases at a rate
commensurate with industrial emissions, implies that the global
temperature should have risen by o. rc since 1950; the measured
trend of 0. 33C is less than half of what was projected.
Manabe et al. still calculate a net equilibrium warming of 4. 0C
in their coupled ocean-atmosphere model, but comparison of
observed behavior of the Northern Hemisphere and that predicted
by the model suggests that, to date, it has overpredicted warming
by at least a factor of 2.
.
Even though the new simulations still appear to be too warm,
they do predict most warming will occur in high-latitude winter of
l. A. Jones, "Historical Records of Cloud Cover and Climate for Australia, "
Australian Meteorological Magazine 39 (1991): 181-89.
359
MARKET LIBERALISM
the Norther Hemisphere. In the new NCAR version (Figure 20. 9),
the area of projected warming of more than 4C is less than 5 percent
of the planetary surface, but more important, because almost all
of it is confined to latitudes higher than 60 in Northern Hemisphere
winter, virtually all of the major warming is projected for either twilight
Figure 20. 9
FOUR 1989 NCAR MODEL PROJECTIONS FOR WINTER
/
' -I:-." -
: *
\
t
~ `


`

Equator Projection, saW

South Polar Projection
360 -
Equator Projecti on, saE
Norh Polar Projection
Global Warming
or nighttime, similar to what has been observed in the climate record.
(Note that compensatory cooling by sulfate aerosol is not included
in those calculations. )
Enhancement of Plant Growth
It has long been known that many plants grow faster in the
presence of elevated concentrations of carbon dioxide, which
shouldn't be surprising: CO
2
is the prime reactant in the overall
equation of photosynthesis. An examination of the scientific litera
ture reveals that 1, 087 individual experiments reported in 324 scien
tific papers, or 93 percent of the studies, found an increase in plant
productivity with an increase in the CO
2
content of the air, while
only 2 percent documented a decrease.
2
1 P. E. Kauppi and his
colleagues have demonstrated that European forests have increased
in biomass during the last two decades; according to those research
ers, "The fertilization effect of pollutants overrides the adverse
affects, at least for the time being. "
22
Further, if warming caused
by an enhanced greenhouse effect occurs primarily during winter
and nighttime, then the growing season will lengthen, increasing
the time during which plants can capture CO
2
,
Several real-world surveys indicate an acceleration in vegetative
growth. According to Sherwood Idso/3 the effect has been noted
in montane species in the western United States, in a carefully
monitored virgin forest plot at the Oak Ridge National Laboratory,
and in the northern forests of Scandinavia.
If plant growth is indeed accelerating, it is doing so at a time when
forest growth is ostensibly being retarded by acid precipitation. If
sulfate aerosol is one (insufficient) factor involved in mitigating
prospective warming, then its negative effects are being countered
in part by enhanced carbon dioxide. An additional factor of environ
mental importance is that enhanced cloudiness serves to block
incoming solar radiation, mitigating effects of a stratospheric ozone
decline. A combination of those factors is probably responsible for
21 K. E. Idso, Plant Responses t o Rising Lels of Atmospheric Carbon Dioxide (Tempe,
Ariz. : Institute for Biospheric Research, 1992).
l. E. Kauppi, K. MieIikainen, and K. Kuusela, "Biomass and Carbon Budget
of European Forests, " Science 256 (1992): 70-74.
23Sherwood B. Idso, Carbon Dioxide and Global Change: Earth in Transition (Tempe,
Ariz. : Institute for Biospheric Research, 1989).
361
MARKET LIBERALISM
the fact that ultraviolet B radiation-the casual agent for basal cell
skin cancer-is actually declining across the United States and much
of the Northern Hemisphere's landmass.
2
4
Conclusion
The best scientific data available indicate that greenhouse warm
ing is less than predicted and that its prevalence at night in high
latitude winter rather than on summer days means that any rise
in sea level will be mitigated and the world's food supply could
increase. Those findings suggest only one thing: the Popular Vision
of climate apocalypse is wrong.
Nonetheless, there have been and there will be excessive pres
sures for economically important mitigation of the Popular Vision.
They should be resisted. The consensus of data indicates that acqui
escing to such pressures will result in an impoverished nation
attempting to fight a problem that never existed. Our policy should
be commensurate with our science.
2
4
). Scotto, G. Cotton, F. Urbach, et al. , "Biologically Effective Ultraviolet Radia
tion: Surface Measurements in the United States," Science 293 (1988): 762-63.
362
Z1 . The Growing Abundance of Natural
Resources
Jerr Taylor
One of the most serious problems now facing the planet
is that associated with historical patterns of unsustainable
consumption and production, leading to environmental
degradation, aggravation of poverty, and imbalances in the
development of countries.
-Agenda Z!, presented at 1992 UN Conference on
Environment and Development
The most fundamental axiom of economics is the objective reality
of scarcity. Productive resources are limited, yet human desires are
virtually unbounded. Resources have thus been scarce since time
immemorial and will continue to be so for all eternity.
From that simple, self-evident fact a corollary hypothesis has
arisen: as population and economies grow
,
resource depletion
accelerates until physical limits are reached and resource exhaustion
occurs. Such a corollary would hardly strike one as radical. After
all, if resources are fundamentally scarce, it stands to reason that
increased demand for them hastens the day when they will disap
pear from the planet.
Warnings of impending catastrophe, which have been around
for almost 200 years, have arisen with increasing frequency in the
20th century. The population explosion in the Third World, coupled
with the dramatic postwar growth of the global economy since
1950, has increased the volume, pitch, and urgency of warnings
that civilization is living on borrowed time. The gasoline lines and
inflation of the 1970s brought warning voices from the intellectual
wilderness squarely into the center of public debate. International
best sellers such as Paul Ehrlich's The Population Bomb, the Club of
Rome's Limits to Growth, and the Carter administration's Global 2000
363
MARKET LIBERALISM
Report all helped convince millions of people that civilization as
they knew it was on the verge of collapse.
Although the boom years of the 1980s temporarily quieted the
voices of doom, the "conservation ethic" has become an institution
alized element of American politics. Both political parties agree that
government must intervene in the economy to protect us from
potentially catastrophic overexploitation of natural resources. The
debate tends to be over "how much" intervention is necessary, not
whether intervention is j ustified in the first place.
Today, government planners, having been judged incompetent
when it comes to overseeing economic production, are firmly
entrenched in the United States with a new mandate: to eliminate
resource waste in virtually every industry while strictly regulating
the use of our supposedly dwindling stock of natural resources.
Many people still believe that conservation is simply not enough,
that it will only temporarily stall our slide into crisis. Indeed, the
authors of Limits to Growth, in their recently published sequel Beyond
the Limits, argue that "even with much more efficient institutions
and technologies, the limits of the earth's ability to support popula
tion and capital are close at hand. "l The only way out of "civiliza
tiona I collapse, " they contend, is to radically reform all elements
of society. "We are talking about a revolution here, not in the
political sense, like the French revolution, but in the much more
profound sense of the Agricultural or Industrial Revolution.
,,
2 And
just what kind of reconstituted American civilization do the "revo
lutionaries" envision? Theirs is the same tired vision that has hyp
notized communitarians for decades: socialism, but this time with
a happy green face. 3
Taking Invento
r
So is it true, then, that civilization is teetering on the precipice
of collapse due to resource exhaustion? Just how far down have
we drawn earth's material abundance?
I Donella Meadows, Dennis Meadows, and Jorgen Randers, Beond the Limits (Post
Mills, Vt. : Chelsea Green, 1992), p. 47.
2Ibid. , p. 219.
ee ibid. , pp. 209-36, for a rather vague but militantly communalistic view of
how a sustainable society might look.
364
Natural Resources
There are three means by which to j udge the extent of our
resource base: proven reserves, price data, and ultimately recover
able stock.
Proven reserves measure the amount of a given resource that
has been discovered and can be extracted profitably given current
prices and technologies. Thus, proven reserves are a function of
economics, not geological abundance. When resource prices are
low, there is little incentive to invest in exploration or development.
Dropping resource prices also make uneconomical exploitation of
certain resources that were economically viable under higher prices.
Although those reserves are moved off the books, so to speak, they
will still be available when prices increase at some point in the
future. Likewise, low resource prices provide little incentive to
invest in research and development efforts for new extraction tech
nologies that often allow previously uneconomical resource fields
to be mined profitably. Only when inventories begin to dwindle
and resource prices begin to rise do commercial enterprises find it
necessary to invest in resource exploration and development.
Thus, proven reserves, although providing useful information
to industry, tell us little about ultimately available resources. As
economists Ronald Ridker and Elizabeth Cecelski noted, "Since
exploration and development are costly, little effort is made to find
proof of new resources if what is already known is considered
adequate to meet demands for the next ten to twenty years.
,,
4
Price data are a far more accurate means by which to evaluate
relative resource scarcity. Basic economics tells us that, in a free
market, prices rise when demand for a resource is greater than
current supply. Likewise, prices fall when the supply of a given
resource is greater than consumer demand. Because prices reflect
the accumulated knowledge of millions of economic actors who
daily put their own money at risk, the market is far more likely to
accurately judge resource scarcity than are noneconomic actors.
Moreover, the needs of future generations are fully considered
in the pricing mechanism. An asset's value is determined by the
projected value of its future returns. Resource owners are thus
4Ronald Ridker and Elizabeth Cecelski, "Resources and Population," in Interna
tional Encyclopedia of Population, ed. John Ross (New York: Free Press, 198), p. 595.
Cited in David Osterfeld, Prosperity versus Planning (New York: Oxford University
Press, 1992), p. 93.
365
MARKET LIBERALISM
fully encouraged to consider the long-term implications of their
management decisions. Resource degradation and depletion are
costly; as soon as the market anticipates future problems with a
commodity, the value of that commodity falls and the owner's
wealth depreciates immediately. Likewise, the maintenance of a
strong resource base increases both the value of a holding and the
wealth of the owner.
Producers of resource materials have an incentive to maintain
adequate stocks for the future simply because potential shortages
in the years ahead will lead to higher prices and thus greater returns
on the sale of commercial resources. The rapid emergence of futures
markets for most resources allows speculators to purchase the rights
to various resources and hold them off the market for resale at
hig
h
er prices in the future. If future supply of and demand for a
resource are poorly reflected by its market price, enterprises that
know better have every incentive to act on their superior knowledge
to garner large future profits.
The third means of examining resource abundance is by reference
to ultimately recoverable stock, defined as a mere 1 percent of a
given resource estimated to be in the top kilometer of the earth's
crust. Although advances in extraction technologies and adjust
ments in resource prices will perhaps allow us to economically
mine a greater proportion of the earth's abundance, it is historically
reasonable (and perhaps even a bit conservative) to assume that
man can use about 1 percent of the earth's mineral and fossil fuel
deposits. s
If we examine the earth's resource base using those three yard
sticks, we do indeed come to a jarring conclusion: at the very time
that the conservation lobby was convincing millions of Americans
and legislatures everywhere that resource shortages were lurking
just around the corner, the global economy witnessed the greatest
explosion of resource abundance in the history of mankind.
If there are indeed "physical limits to the sources of materials
and energy that sustain the human population and the economy,"
as is contended in Beond the Limits, it appears that those limits are
5WiIliam Nordhaus, "Resources as Constraint on Growth?" American Economic
Review, May 1974, pp. 22-26.
366
Natural Resources
so far beyond the human horizon that they are for all intents and
purposes nonexistent.
Energy
Contrary to popular belief, energy stocks of all kinds, both fossil
and nonfossil, have been increasing steadily and dropping in price.
We face unprecedented abundance, not scarcity.
As noted by MIT professor Morris Adelman, one of America's
foremost energy experts, "The great oil shortage is like the horizon,
always receding as one moves toward it.
,,
6 The world has nearly
10 times the amount of proven oil reserves that it had in 1950 and
almost twice the known reserves of 1970. In fact, proven oil reserves
are greater today than at any other time in recorded history.
Oil prices have dropped 35 percent in constant dollars since 1980.
When indexed to U. S. wages, oil prices have dropped 43 percent
since 1980 and show steady and continuing declines in price from
as far back as 1870. 7 The decline in oil prices has been refected in
the price of gasoline at the pump. Fuel prices in constant dollars
are 6 percent lower today than they were in 1972 (just before the
OPEC oil embargo), 25 percent lower than in 1963, and 30 percent
lower than in 1947.8 Whereas 3. 2 percent of total household expen
ditures were devoted to gasoline in 1972 (the lowest such rate since
1952), American households today devote but 2. 6 percent of total
expenditures to gasoline purchases.
9
Proven natural gas reserves have also shown dramatic increases
in the past 20 years; they have increased by 8 percent since 1974.
At current rates of consumption, proven gas reserves alone will be
sufficient for approximately 58 years. 1O The fact that natural gas
prices, after adjusting for inflation, have dropped only 3 percent
since 1980 is largely a function of price and production controls
6Morris Adelman, "Oil Fallacies," Foreign Policy 82 (Spring 1991): 10.
7Stephen Moore, "Doomsday Delayed: America's Surprisingly Bright Natural
Resource Future," Institute for Policy Innovation Policy Report no. 1 18, July 1992,
pp. 35-0.
BDaniel Yergin, "Gasoline and the American People," Cambridge Energy
Research Associates, June 1991, p. 15.
9
Ibid. , p. 17.
lO"Energy and the Environment: A Power for Good, a Power for Ill," The Economist,
August 31, 1991, survey, p. 4.
367
MARKET LIBERALISM
that lingered into the 1980s and discouraged optimum production
levels.
Likewise, between 1979 and 1989 proven coal reserves grew by
84 percent, an amount sufficient for 238 years given current levels
of consumption. On an energy equivalent basis, proven reserves
of coal are 43 percent greater than the world's combined total of
proven oil and natural gas reserves. 1
2
Since 1980 the price of coal
has dropped 91 percent when adjusted for inflation and 243 percent
when indexed to U. S. wagesY
Economist William Nordhaus concludes from U. S. Geological
Survey data that the world has enough ultimately recoverable fossil
fuel reserves to last approximately 520 years given projected rates
of demand, although others have pegged that figure as high as 650
years.
I
4 If historic rates of productivity increase and technological
advances are considered, then we have every reason to believe
that the l, OOO-year trend of falling energy prices will continue for
generations to come.
Remember, the figures cited above are for fossil fuel reserves
only. Current nuclear technology ensures that the world has 8,400
years of energy for the future at current rates of consumption.
I
S
Advances in nuclear breeder and fusion technolOgies would ensure
vast supplies of energy for tens of thousands of years, and geother
mal resources and the potential of solar energy also promise virtu
ally limitless supplies of energy as technology improves and those
sources become more economically competitive.
Mineral Deposits
Back in 1980, during the height of the Carter-era resource deple
tion scare, economist Julian Simon bet conservationist Paul Ehrlich
$1 , 000 that the real price of any group of natural resources of
Ehrlich's choice would be less at any given date in the future than
in 1980. Ehrlich chose five minerals-copper, chrome, nickel, tin,
and tungsten-and set the payoff date for 10 years hence. As Simon
l
llbid.
12National Coal Council, "The Long-Range Role of Coal in the Future Energy
Strategy of the United States, " June 190, p. 3.
1
3Moore, pp. 35-.
14See Nordhaus and "Energy and the Environment. "
ISNordhaus, p. 25.
368
Natural Resources
expected, the real price of those five resources dropped by 24 per
cent, 40 percent, 8 percent, 68 percent, and 78 percent, respectively.
Ehrlich sent Simon a check-but no admission of error-in 1990.
No matter which minerals Ehrlich chose, it was a sucker's bet.
All but two strategic minerals (manganese and zinc) declined in
price during the 1980s, reflecting the dramatic increase in mineral
abundance that has occurred globally since the beginning of time.
Simon renewed his offer to any and all comers in 1992, but to date
there have been no takers. As the data in Table 1 indicate, proven
reserves of virtually all important minerals have skyrocketed since
1950.
An examination of the price of 13 metals and minerals (aluminum,
antimony, copper, lead, magnesium, manganese, mercury, nickel,
platinum, silver, tin, tungsten, and zinc) shows a net 31 percent
decline in real prices from 1980 to 1990. When indexed to wages,
those price declines are even more dramatic. "Most of the minerals
and metals at the turn of the century were five to ten times more
Table 2 1 . 1
PROVEN RESERVES OF VARIOUS RESOURCES, 1950-90
(MILLION METRIC TONS)
Resource 1950 1990 Change {%}
Bauxite 1, 400 21 ,500 1 , 436
Chromium 70 420 500
Copper 100 350 250
Iron ore 19, 000 145,000 663
Lead 40 70 75
Manganese 500 980 96
Nickel 17 59 247
Oila 104 1, 002 863
Tin 6. 0 4. 2 30
Zinc 70 145 107
SOURCE: Kahn, Brown, and Martel, p. 92; U. s. Bureau of Mines, M|oce|
Cee1|||cs Seep, January 1990; kcseeccs(eicc1e, Report of the
President's Materials Policy Commission, 1952, vol. 2, p. 27; and ocg
S|e||s||csSeecc 8ee| (New York: PennWell, 1991), pp. 143, 151.
NOTE: Information on proven reserves of coal, magnesium, natural gas,
and titanium in 1950 is unavailable.
"Billion barrels.
369
MARKET LIBERALISM
expensive than they are today in terms of numbers of hours of
work needed to purchase them.
' '
Declines in metal and mineral prices are reflected i the equally
dramatic declines i raw material costs. From 1980 to 190 the real
price of glass fell 33 percent, cement prices fell 4 percent, metal prices
dopped 18 percent, and rubber prices declined by 4 percent. 17
Examination of ultimately recoverable mineral resources indi
cates that we have only begun to tap the rich veins of the earth's
abundance. U. S. Geological Survey data reveal that, if current con
sumption trends continue, recoverable mineral resources will last
for hundreds and in many cases thousands and even tens of thou
sands of years. 18 Physicist Herman Kahn and several colleagues
concluded in 1976 that "(wer 95 percent of the world demand [for
minerals] is for five metals (iron, aluminurauxite, silicon, magne
sium, and titanium), which are not considered exhaustible. "
Another 4. 85 percent of world mineral demand is for seven metals
(copper, zinc, manganese, chromium, lead, nickel, and tin) that
are "probably inexhaustible. " Thus, 99. 9 percent of all mineral
demand is for metals virtually inexhaustible over any conceivable
time horizon. 19
Agricultural Resources
The disturbing, ongoing pattern of famine and drought in Africa
and Asia has added credibility to the argument that the earth is
approaching a point at which it will not be able to continue to feed
the "teeming masses" of the planet. Yet by any analysis, this is a
time of agricultural abundance unprecedented in the history of the
world. Economist Thomas De Gregori observes that "if there is
hunger in the world-and so there is, in abundance, even in
wealthy countries-it is because of maldistribution of food, not
insufficient global production.
,,
2
o Ten times as many people died
of famine in the last quarter of the 19th century as have died of
16Moore, pp. 25-31 .
17Moore, p. 32.
18Nordhaus, p. 23.
19Herman Kahn, William Brown, and Leon Martel, The Next Z00Years (New York:
William Morrow, 1976) p. 102.
homas De Gregori, "Resources Are Not; They Become: An Institutional The
ory," Journal of Economic Issues 21, no. 3 (September 1987): 1252.
370
Natural Resources
famine in the third quarter of the 20th century, despite our much
larger present population and the massive engineered famines in
Cambodia during the 1970s.
2
1
An examination of 15 representative agricultural commodities
(barley, broilers, carrots, cattle, corn, cotton, eggs, milk, oats,
oranges, rice, sorghum, soybeans, wheat, and wool) reveals that
real prices in the United States dropped by an average of 38 percent
from 1980 to 1990. When indexed to wages, the price of those
foodstuffs has declined 83 percent since 1950.
22
Clearly, if the earth's
agricultural productivity were being outpaced by voracious demand
for food as a result of the population explosion, agricultural prices
would be rising sharply rather than falling dramatically as the data
indicate.
Likewise, it is clear that the agricultural output of the planet has
increased exponentially over the past several centuries. Since 1960
technological advances in farm equipment, pesticides, fertilizers,
irrigation techniques, bioengineering, and soil management have
led to a doubling of world food production and 30 percent increases
in farmland productivity. Technological advances have more than
kept pace with the explosion in global population. Since 1948 world
food production has surpassed population increases by about 1
percent a year.
2
4 Although global population has doubled since
World War II, world grain production has tripled.
The dramatic increase in the availability of foodstuffs occurred
without any appreciable global increase in land committed to
agricultural uses over the last 30 years. Since 1950, in fact, 200
million acres of u. s. farmland have been retired as a result of
the unprecedented glut of agricultural commodities on the world
market.
Agricultural abundance has translated into improved health for
even the poorest in the Third World. Whereas only 42 percent of
all countries reported that average daily caloric consumption
21
Julian Simon, Population Ma Iters (New Brunswick, N. J. : Transaction Books, 1990),
pp. 43-45.
22Moore, pp. 12, 16-19.
20ennis Avery, "Sustainable and Beneficial Agriculture," Paper presented at
Cato Institute conference on "Global Environmental Crises: Science or Politics?"
June 1991, p. 1 .
240sterfeld, p. 61.
371
MARKET LIBERLISM
reached 100 percent of recommended levels in the mid-1960s, 66
percent of all nations reported caloric intake at those levels by the
mid-1980s, a 56 percent increase in less than 20 years. Fully 81
percent of the world's countries, including China and India, now
report average caloric intake of at least 90 percent of recommended
levels.
2
5
Moreover, there is good reason to believe that the planet can feed
tens of billions of people for many generations to come. Suitable
agricultural land makes up 24 percent of the total ice-free landmass
of the globe, well over twice the amount cultivated in recent decades
and more than triple the acreage cultivated in any given year.
2
6
Moreover, a great deal of the world's cropland is underused or
cultivated using low-yield technologies and practices similar to
those used in this country in 1910. Obviously, agricultural produc
tivity will skyrocket as high-yield technologies continue to advance
throughout the developing world.
Yet even those expansive limits are not fixed. Agricultural history
is largely defined as the transformation of land unsuited for cultiva
tion into productive cropland. Nobel laureate Theodore Schultz
observes that "the original soils of wester Europe, except for the
Po Valley and some parts of England and France, were in general
very poor in quality. As farmland, these soils are now highly pro
ductive. A substantial part of the productivity of farmland is man
made by investments in land improvements.
,,
2
7 Political economist
David Osterfeld points out that "much of the American Midwest
was forest and swampland. No account of arable land in, say, 1800
would have included it. Now, after it has been cleared and drained,
it is among the most fertile lands in the world. And the elimination
of the tsetse fly would open up to cultivation about 200 million
hectares of African land, an area larger than the total cropland in
the United States.
,,
2
8 Productive farmland is not some sort of fnite
2
5World Resources I nstitute, World Resources I Jb/ (New York: Basic Books),
pp. 252-53.
26Roger Revelle, "The World Supply of Agricultural Land," The Resourcel Earth,
ed. Julian Simon and Herman Kahn (New York: Basil Blackwell, 1984), pp. 184-201.
27
Theodore Schultz, in Lectures i n Agricultural Economics (Washington: Economic
Services Bicentennial Lecture Series Committee, 1977), pp. 16-17. Cited in De Gre
gori, p. 1254.
280sterfeld, p. .
372
Natural Resources
given; it is, instead, a function of agricultural skill and technology,
two "resources" that have been expanding rapidly over the centu
ries and exponentially over the past 80 years.
Simply increasing the efficiency of water use in developing
nations could provide enough advances in productivity to support
a global population of 35 billion to 40 billion people, between seven
and eight times the current population of the world.
2
9 And then
there is the coming revolution in biotechnology, a science well on
its way to producing crops that are able to resist drought, insects,
disease, and salinity and thrive in the harshest soils and previously
inhospitable environments. Because of the projected low costs of
those new products, biotechnology will probably have its greatest
impact in the developing world, enabling poor farmers to take full
advantage of the agricultural revolution and to afford the relatively
costly inputs required to make high-yield farming economical.
Although conservationists argue that accelerating soil erosion
will make those productivity gains short-lived and illusory, the
facts speak otherwise. Most of the world's worst soil erosion prob
lems are the result, not of modern high-yield farming, but of
attempts to use low-yield, traditional agricultural techniques on
fragile soils.
Studies by the U. S Department of Agriculture, the University
of Minnesota's Soil Sciences Department, and economist Pierre
Crosson of Resources for the Future all conclude that, at current
erosion rates, heavily farmed soils in the United States might lose
3 to 10 percent of their inherent fertility over the next 100 years.
Such small losses are sure to be more than offset by continued
improvements in agricultural productivity even if no new conserva
tion techniques are adopted. As Crosson noted:
The success of the new [high-yield] technologies strongly
suggests that erosion damage to soils in the main crop
producing regions of the country was not and is not as
severe ar is sometimes claimed. Soil scientists have acknowl
edged that even severely eroded soil can be restored to high
productivity with investments of human skill and other
resources, even though they may seem to forget this when
2Ibid. , pp. 67, 83.
:ennis Aver, Global Food Progress I JJI (Indianapolis: Hudson Institute, 1991),
pp. 78-79, 81, 24.
373
MARKET LIBERALISM
they make pronouncements about the erosion threat. Con
tinuation of present rates of erosion throughout most of the
next century would pose no serious threat to the productiv
ity of the nation's soils.3!
Timber Products
The fear that mankind is rapidly deforesting the globe has arisen
on and off ever since the 18th century. Yet precious little evidence,
other than anecdotes, has ever been advanced to support that
lamentably widespread belief.
According to the most recent UN data, the most authoritive
figures at our disposal, world forestland today covers 4 billion
hectares, more than 30 percent of the total global land area. That
figure has not changed appreciably since 1950, even in the midst
of the population explosion, massive economic growth, and urban
ization of the globe. Today forestland occupies about one-third of
the United States, and that proportion has been expanding steadily
for over 70 years. According to the U. S. Forest Service, 2 million
new cubic feet of wood are grown annually in the United States,
while only 16. 5 million cubic feet are harvested. Net annual growth
exceeds annual harvests in commercial forests by 27 percent.
Since 1920 U. S. forests have expanded by 57 percent, a remark
able fact given that during the same period the U. S. population
doubled, the economy grew by a factor of 6, and per capita output
increased by a factor of 3. Forestland has increased by 27 percent
since 1952.3
2
Although demand for wood products today is at an
all-time high, the United States is still able not only to meet demand
with currently available timber stock but to continue adding to
forest reserves. In fact, there is only one-third less forestland in
the United States today than there was in the 1600s when European
settlers first encountered it.
An example of the striking increase in U. S. forest reserves is
found in New England, where logging thrived in the 19th century.
From the mid-1800s to 1980 the amount of land covered by forests
31 Pierre Crosson, "Cropland and Soils: Past Performance and Policy Challenges,"
in America's Renewable Resources, ed. Kenneth Frederick and Roger Sedjo (Washing
ton: Resources for the Future, 1991), pp. 190, 191, 196.
32
Roger Sedjo, "Forest Resources: Resilient and Serviceable," in America's Renew
able Resources, pp. 81-1 15.
374
Natural Resources
increased from 74 to 90 percent in Maine; from 50 to 86 percent in
New Hampshire; from 35 to 76 percent in Vermont; and from 35
to 59 percent in Connecticut, Massachusetts, and Rhode Island. 33
That growth in forest reserves is reflected in the price of various
wood commodities. The real prices of lumber and paper have fallen
by 10 and 25 percent, respectively, since 1980. When indexed to
wages, lumber prices today are one-third those of 1950, one-sixth
those of 1900, and one-tenth those of 1800. Likewise, the cost of
paper when indexed to wages is less than half that of 1930. 3
The increased supply of wood has not come at the expense of
rugged, pristine nature preserves. From 1980 to 1989 land classified
as wilderness increased by 29 percent. Although environmentalists
argue that the second-growth forests of today are ecologically infe
rior to the old-growth forests that the colonists encountered three
centuries ago, Roger 5edjo of Resources for the Future points out:
In the United States, the forest estate consists of a wide
array of forest types and ages. In this regard it is not too
different from the mosaic of forest types present during the
time of early settlement. The species found in these stands
are usually similar to those that would have existed there
at settlement. Even in most forest plantations in the United
States the species composition mimics the forest that would
have naturally regenerated there. By most criteria, U. S. for
ests are in excellent condition. U. s. forests have shown the
potential to deliver large volumes of wood on a sustainable
level into the indefinite future. 35
Market Liberalism and Resource Creation
50 how does one explain the unprecedented abundance of natu
ral resources today, an explosion of plenty in the very midst of
record demands for resources?
One school of thought holds that the world's economic growth
since World War II is historically atypical and that our half century
of prosperity since then is the result of "a fortuitous confluence of
nJohn Barrett, "The Northeast Region, " in Regional Silviculture of the United States,
ed. John Barrett (New York: John Wiley & Sons, 1980), pp. 25, 37. Cited in Sedjo,
p. 109.
3Moore, pp. 21-24.
35Sedjo, pp. 1 1 1-14
375
MARKET LIBERALISM
favorable events" that cannot be counted on again. The revolution
of high-yield agriculture, favorable weather, massive petroleum
finds in the Middle East, the exploitation of the last hectares of
virgin land, and countless other events are one-time gains that
have shielded man from the true reality of his condition. As those
events run their course in the 1990s, we are due for a jarring return
to global reality.
Yet declining resource scarcity is a long-term trend, evident from
the beginning of human society. Without exception, every material
resource imaginable has become more abundant during the course
of civilization. Whether measured in terms of proven reserves or
prices relative to income, a graph of the relative abundance of
virtually every resource looks like the population graphs we have
seen so many times before: long-term, steady growth in resources
with an exploding, exponential increase in resource availability over
the last 200 years. The record of the last 50 years, then, is not
atypical but perfectly consistent with the observable data on increas
ing resource availability since the beginning of time.
Another view holds that we are a world in "overshoot," living
off our resource capital and not our income, irresponsibly and
rapidly drawing down precious stocks of resources that have taken
eons for the earth to accumulate. The authors of Beyond the Limits
argue that "overshoot comes from delays in feedback-from the
fact that decisionmakers in the system do not get, or believe, or
act upon information that limits have been exceeded until long
after they have been exceeded. Overshoot is only possible because
there are accumulated resource stocks that can be drawn down. "3
That argument, however, is in direct contradiction to every possi
ble measurement of resource scarcity and the march of recorded
history. If overshoot occurs when we use resources faster than they
are created by nature, then the world has been in accelerating
"overshoot" for the last 10, 000 years, or ever since the development
of agriculture. Moreover, our best "feedback" on scarcity-market
prices-tells us that resources are expanding, not contracting
(Table 2) .
Virtually every year since 1800 a book, study, report, or commis
sion has pronounced the imminent depletion of this or that resource
3Meadows, Meadows, and Randers, p. 137.
376
Natural Resources
Table 21 . 2
RESOURCE PRICES INDEXED TO WAGES, 1950-90
(RELATIVE TO 1990 BASELINE)
Year
Resource 1950 1960 1970 1980 1990
Food" 386 210 145 161
Lumber 170 1 14 95 126
Paper 139 121 97 104
Mineralsb 194 147 179 217
Ener 184 126 74 138
SOURCE: Moore, pp. 18-19, 23, 30-31, 40.
100
100
100
100
100
Change ( %)
1950-90
-74
-41
-28
-48
-46
"Includes barley, broilers, carrots, cattie, corn, cotton, eggs, milk, oats,
oranges, rice, sorghum, soybeans, wheat, and wool.
bIncludes aluminum, antimony, copper, lead, magnesium, manganese,
mercury, nickel, platinum, silver, tin, tungsten, and zinc.
cIncludes coal, electricity, natural gas, and oil.
on the basis of indices that examine current trends and known
reserves. Yet every one of those pronouncements has been not
only wrong but spectacularly and embarrassingly wrong.37 More
efficient technologies that require fewer resource inputs, advanced
extraction and harvesting technologies that allow far greater access
to resource deposits, and material substitutions that replace scarce
resources with far more abundant resources are just a few of the
routine advances that mark the entire march of human civilization.
The fundamental flaw in the conservationist paradigm is the
premise that global resources are created by nature and thus fixed
37 As noted by Nobel laureate Friedrich Hayek, "Industrial development would
have been greatly retarded if sixty or eighty years ago the warning of the conserva
tionists about the threatened exhaustion of the supply of coal had been heeded;
and the internal combustion engine would never have revolutionized transport if
its use had been limited to the known supplies of oil . . . though it is important
that on all these matters the opinion of the experts about the phYSical facts should
be heard, the result in most instances would have been very detrimental if they had
had the power to enforce their views on policy. " Friedrich Hayek, The Constitution of
Liberty (Chicago: University of Chicago Press, 1960), pp. 369-70.
See further James Bennett and Thomas DiLorenzo, Offcial Lies (Alexandria,
Va. : Groom Books, 1992), pp. 132-56; Ronald Bailey, ECO-SCAM: The False Prophets
of Ecological Apocalypse (New York: St. Martin's, 1993), pp. 40-78; and Osterfeld,
pp. 85, 103.
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MARKET LIBERALISM
and finite. Not a single material resource has ever been created by
"nature. " Human knowledge and technology are the resources that
turn "stuff" into useful commodities. What we think of as resources
are actually certain sets of capabilities. As De Gregori points out,
"Humans are the active agent, having ideas that they use to trans
form the environment for human purposes . . . . Resources are not
fixed and finite because they are not natural. They are a product
of human ingenuity resulting from the creation of technology and
science .
Two hundred years ago petroleum was just a useless ooze that
actually drove down property values. Human creative endeavor,
knowledge, and technology, however, turned the ooze into a valu
able resource. Likewise, sand has never been considered a resource,
but the revolution in telecommunications and man's expanding
technological capacity have turned sand into a valuable commod
ity-the basic resource from which computer chips and fiber-optic
telecommunication devices are made.
"Since resources are a function of human knowledge, and since
our stock of knowledge has increased over time, it should come
as no surprise that the stock of physical resources has also been
expanding," observes Osterfeld. 39
The free, competitive marketplace is the most efficient engine of
resource creation and conservation because it is the most explosive
engine for intellectual and technological advance. Technological
advance, the heart of resource creation, depends heavily on the
competitive free exchange of ideas, entrepreneurial activity, invest
ments in capital and labor, and a profit mechanism.
The size of our resource pie is determined not by nature but
by the social and economic institutions that set the boundaries of
technological advance. Closed societies and economies under the
heavy hand of central economic planners are doomed to live within
the confnes of dwindling resource bases and eventually experience
the very collapse feared by the conservationists. Liberal societies,
built on free markets and open inquiry, create resources and expand
the possibilities of mankind.
30e Gregori, pp. 1243, 1247.
30sterfeld, p. 9.
378
ZZ. Why Health and Safety Are
Products of Competitive Institutions
Aaron Wildavsk
Why is richer safer, if I may presume upon old titles, and wealth
ier healthier?! For one thing, health and safety are collective prod
ucts. No one does it alone. No one. The most physically fit person
who follows all the admonitions for the healthy life might not last
a minute in the former Yugoslavia. Kings and nobles in other times
and poorer societies lived notoriously uncomfortable and unhealthy
lives, even though they had more than anyone else. But those
examples are too dramatic. In some neighborhoods, it is reasonably
safe to go to and return from work, and to walk the streets; in
other neighborhoods, it is not. The chance of being run over by
irresponsible drivers or inhaling fumes from untuned cars varies
greatly from place to place. We already know that by far the most
dangerous thing a man can do is stay unmarried, and though
women are better able to live alone, unmarried women have far
worse health than married women. (It is possible that long-lived
same-sex liaisons would show the same results, not least because
of the reduction in the probability of getting AIDS, but I have not
seen relevant research. ) The point is that if safety depends on others
as well as on ourselves, the quality of the institutions that relate
us to those others matters.
Safet Is a Social Phenomenon
The care we give and get goes to and comes from others. The
resources we use to promote and protect ourselves involve others.
Indeed, our health and safety are far more a product of collective
construction than of what any single individual can do. Nowhere
I
Aaron Wildavsky, "Richer Is Safer," Public Interest 6 (Summer 1980): 23-29;
and Aaron Wildavsky, "Wealthier Is Healthier," Regulation, January-February 1980,
pp. 10-12, 55.
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MARKET LIBERLISM
is that more evident than in natural disasters. What happens may
be a product of natural forces, but the human response depends on
societal capacities. Hurricanes and tidal surges of great magnitude
recently struck the American states of Florida, Louisiana, and
Hawaii. Although there were large losses of property, reflecting
the wealth of those areas, little or no life was lost. That is remark
able. Soon thereafter, huge floods struck Pakistan. Thousands died.
Why the difference?
It is hardly that Americans care more about each other or, more
to the point, are better able to figure out and carry out individual
strategies of preservation. True, Americans are considerably richer,
and a few with the highest incomes might be able to fly out of
harm's way, but the vast majority, even if they take recommended
precautions, such as boarding their windows and stocking food
and water, are limited in how far they alone can protect themselves.
It is not wealth per se but what it stands for that helps secure
safety-early warning; better (not perfect) housing construction;
better transportation; more of everything, including organizational
capacity and expertise, to ward off the worst and provide assistance
where it is needed. There is chaos too, but comparatively speaking,
the rich have the resources to move, as we used to say, the fastest
with the mostest. It is the quality of our institutions, our ways of
relating to each other, that improves health and safety in society
as a whole.
Health and safety are functions of genetic inheritance, personal
habits, and the accumulation of flexible social resources that can
be used to ameliorate difficulties as they arise. Genetic inheritance
is, of course, personal, and there is not much we can do about
it, although biotechnology is beginning to open up prospects of
ameliorating the worst defects. Good personal habits, which may
be summed up as moderation in eating, drinking, sleeping, and
worrying, but no smoking, are known to exert great influence on
health. The poor person with good personal habits is likely to be
healthier than the rich person who overeats or eats irregularly,
sleeps fitfully, worries too much, and otherwise leads a disorderly
life. (Yet it is easier for rich people to lead regular lives. ) The accu
mulation of societal resources that fills in the cracks of individual
differences in genetic inheritance and personal habits has produced
the consistent decline in morbidity and mortality that has occurred
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Health and Safety
everywhere in the Western world. What is it, I ask, along with
countless others, that nations with the healthiest people have in
common? The answers, known to everyone but not heretofore
directed to health and safety, are democracy, science, and capital
ism. There is no getting away from it: if you want your children to
be healthier, see that they are born in scientifically strong capitalist
democracies. Because health and safety are part and parcel of the
standard of living in a given society (another way of saying that
richer is safer), to become safer a society also has to become richer.
Why, I ask again, do wealth and health go together? What is the
institutional connection among wealth, health, democracy, capital
ism, and science?
If we think of science as competition in ideas, democracy as
competition for office, and capitalism as competition for resources,
it is clear that institutions that facilitate competition are the key.
The common experience of collapsed command economies shows
us that uncompetitive institutions can make people not only poor
but sick; the indicators of health and safety for command economies
are much worse than those for capitalist democracies. Yet the ex
communist countries deliberately set out to improve public health,
whereas science, democracy, and capitalism are institutional
processes by which individuals and groups compete, not to achieve
any particular purpose such as enhancing safety and health, but
to improve themselves.
Why Markets Are Safer Than Hierarchies
If capitalism is bad for our health, how can we support it? How
do we face ourselves in the mirror, knowing that in our insatiable
desire for profit we have eaten out the substance of numerous
unsuspecting individuals, despoiled the natural environment, and
corrupted the moral climate?
That would not necessarily be an important question if there
were not a worldwide movement attempting to convict corporate
capitalism of causing cancer. If Joe and Paul have grocery stores
on opposite sides of the street, and if Joe wants to drive Paul
out of business, do you suppose he can convince residents of the
neighborhood that if they buy from Paul they will get cancer?
In America you can hardly pick up a newspaper without finding
numerous discussions of insidious external contamination, coming
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MARKET LIBERALISM
from industry and technology, that poisons people. Nuclear waste
is not the only hazard fingered; the foods we eat, the air we breathe,
the water we drink, and the land we live on are also suspect. Do
you suppose a civilization would survive if it could not abide its
own waste products? What better way to counter despised social
forms than by showing that they are unhealthy?
What are the facts? People in capitalist democracies are the rich
est, longest lived, and healthiest people in world history. In the
last decade, life expectancy has increased substantially. Accident
rates are down, indices of health are up. Even cancer rates are
declining: If you will allow me to kill off everybody at age 35, the
age at which people used to die, then I would immediately reduce
cancer rates, since cancer is a disease of old age. If we control for
age and cigarette smoking, the incidence of most forms of cancer
is down. It would make more sense for us to worry about how we
are going to live as we all get old and fall all over one another,
as happens in the marvelous science fiction movie Soylent Green.
Longevity is also associated with competitive institutions.
If we are living longer rather than shorter lives, how do we
explain the anomaly of the immense concern about danger, which
is exactly contrary to the evidence? If you believe that social relations
should be egalitarian, you want to ream out the economic markets
that support the opposing way of life. If you are interested in the
facts, you accept certain conclusions that were the staples of every
social reformer of the 1930s and 1940s-for one, richer is safer. If
you rank the countries of the world, is it the poorer people or the
richer who are healthier and whose environment is better?
Why is it, then, that through all sorts of regulatory and risk
aversion measures we want to make ourselves poorer in order to
make ourselves healthier? Behind risk aversion is the idea that
if you slow down technological development, you make people
healthier. Three reasons are usually given to explain why capitalism
is bad for our health: risks are hidden-we are not told about them;
involuntary-we would not accept them if we knew them; and
irreversible-there is no recovery. In 30 years our health will deteri
orate. What philosopher, I ask, said the opposite, namely, that
the benefits are hidden-you don't know you're getting them;
involuntary-you get them whether you want them or not; and
irreversible-if you play by the rules of the game, you always get
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Health and Safety
the same result. Of course, that is a rather abstract version of Adam
Smith's Wealth of Nations. Which paradigm is correct? Do you get
healthier by making yourself poorer or by making yourself richer?
Amazingly enough, I cannot find a single article in the economic
literature, including literature by libertarians and objectivists, on
the relation between capitalism and health and safety. It seems to
be a topic not covered; either the relation is assumed or it is totally
neglected. I see in a few newspapers that when asked about the
"richer is safer" thesis, economists say it is part of their mainstream.
Good. But there is no literature that explains why, as industrial
capitalism developed, people got healthier.
We know that as wealth diffused in society, peQple became more
valuable and there were more resources with which to do things
such as invest in science and undertake public health measures.
As individuals gained greater command over resources, they were
able to purchase more of their own health. I do not mean merely
that they were able to purchase more medical care, which has
rapidly diminishing returns, but vacations, baby sitters, labor-sav
ing devices, beauty aids, anything that an individual believes will
enhance health. Because no central authority can know as well as
individuals what will make them feel better, the diffusion of wealth
is as important as its accumulation. Wealth, it should be under
stood, is a proxy for the capacity to accumulate other flexible
resources-energy, knowledge, communications, organizational
capacity-that enable individuals to do for themselves. We also
know that the spread of technological innovation led to an agricul
tural revolution, which provided a lot more calories to go around,
and calories (up to a point, of course) are good for your health, as
you discover when you are hungry. The agricultural innovators
were not necessarily motivated by the desire to do good for man
kind. They had the usual sorts of motivations-lust for power,
greed, envy-as well as that of meeting other people's needs. Thus,
we can begin to sketch out a little bit of a theory of how capitalism,
by indirectly spurring production and wealth, created opportunities
for better health.
Here we must go back to the Smithean premise and ask, How
did we became healthier, since that was not anyone's avowed inten
tion? Indeed, what stops capitalists from making people sicker to
make money? On a systemic level, we understand: if you kill your
383
MARKET LIBERALISM
customers, they will not buy from you again. That gives us a
moment of pause, but not too great a moment. We also know that
it is not worthwhile making people sick. They sue you. And those
who do make people sick do not do as well as others who keep
them healthy.
People are harmed by technology; there is no denying it. The
use of coal to generate electricity, for example, is known to have
caused millions of deaths over the years. Practically everything
that is good-love, children, food, friendship-also harms us. The
axiom of connectedness2 states that the good and the bad effects
of virtually everything are intertwined; you can't have one without
the other. The purpose of institutions, insofar as they have a com
mon purpose, is to develop processes that provide more of what
is desired and less of what is not. I call this the Los Angeles problem:
if you go there for the sunshine, you also have to take some of the
smog. Life comes wrapped in bundles of good and bad; what is
interesting is how one grows in comparison with the other.
One possibility is that, as alternative products are tried, some
turn out to be just as profitable as others and a little better for your
health. And over time they get selected out. A clue is provided in
Schumpeter's notion of creative destruction. As capitalism devel
ops, it both extinguishes forms that used to exist and creates new
forms. If the major problem is that life is too complicated to antici
pate and therefore protect against evils, we need to be in a position
to cope with the unexpected. Two things follow. One is that the
old forms of variety that were good for their time are not good for
this time; if they were good for this time, the unexpected would
not occur. The other is that, in order to deal with future ills of a
magnitude and kind we know nothing about, we need to be able
to take numerous, diverse, and independent forms of action.
This, I believe, is exactly what capitalism does. It makes room
for the new by extinguishing some of the old; it creates all sorts of
variety that cannot be justified entirely on the basis of its contribu
tion to some specific good. Nothing that we now know we need
copes with the unexpected, because it is precisely our inability to
anticipate the unexpected that is the difficulty.
2
For the full argument, see Aaron Wildavsky, Searching for Safety (New Brunswick,
N. J. : Transaction Books, 1988).
384
Health and Safety
How, I ask, might we sample the truly unexpected? The problem
is not merely that we do not know the probability of events' occur
ring, but that we may be surprised (think of AIDS) by wholly
new classes of events. Should governments conduct studies of the
unknown? No doubt. But records of predictions are poor. However,
the existence of independent centers of decision, each, within broad
limits, allowed to go its own way, is a partial solution to the prob
lem. For each organization (or firm) samples the environment differ
ently. Absence of central direction, allowance for peculiarity and
failure, and incentives to act differently so as to profit from innova
tion make possible a broader scan of the potential universe, albeit
not by a single decisionmaker at a single time.
Under competitive capitalism (excuse the redundancy), anticipa
tion is decentralized. Not everyone, by any means, anticipates the
same sort of thing. The probability of being both exactly right and
precisely wrong declines. But the likelihood that someone will antic
ipate the unexpected and learn to cope with it is much greater than
under central control.
Risk-Risk or Health-Health Analysis
If health and safety are indeed functions of a society's standard
of living, it follows that seeking safety without considering how it is
produced is counterproductive. Instead, every proposal or activity
designed to improve health and safety should be subject to risk
risk (sometimes called a health-health) analysis. When people say
that you care only about money whereas they care only about
health, the contest is unequal. Instead, invoking the richer-is-safer
thesis, I have proposed comparing health to health by going risk
to risk-comparing the consequences for both health and safety of
government regulations with the consequences in the absence of
such regulation. There are those, to be sure, who believe that decla
rations of love are forever; that if you promise safety, safety is what
you get; and that only noble feelings are aroused in the name of
liberty. But if there are still people from Missouri who like to be
shown, a risk-risk analysis is appropriate. It requires two steps: ( 1)
From whatever health and safety benefits are postulated, subtract
the harm done, if any, by the remedial ert. All construction and
destruction, transportation, dirt moving, ladder climbing involves
a low but palpable level of danger. To alter the adage slightly, there
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MARKET LIBERALISM
is no such thing (recall the axiom of connectedness) as riskless
health and safety. (2) Subtract again the adverse consequences for health
and safety of lowering the standard of living.
Rather than repeat what I have said elsewhere, I would like to
quote directly from Ralph Keeney's quantitative model of "Mortal
ity Risks Induced by Economic Expenditure. "
Existing evidence shows that lower incomes are associated
with higher mortality risks . . A model is developed for
estimating the number of fatalities possibly induced by eco
nomic expenditures . . . . These results suggest that some
expensive regulations and programs intended to save lives
may actually lead to increased fatalities . . . . Health and
safety are improved via social mechanisms, such as educa
tion and "upgraded" associations, both of which are posi
tively influenced by more disposable income, as well as
directly by individual actions . . . . A general increase in the
standard of living influences societal structure. A wealthier
society leads to the development of a better and more
diverse medical research establishment, to larger markets
to stimulate creation of safer products, to an infrastructure
of health clubs and many opportunities for exercise, and to
the societal resilience to rapidly and efficiently attack new
unforeseen problems threatening our collective health and
safety . . . . For example, using Kitigawa and Hauser data
and allocating costs proportional to income, there is an
induced fatality for every $7. 25 million spent if all the
assumptions in the model are felt to be reasonable. How
ever, again, it is important to stress that calculations in this
paper are illustrative only.3
The principle, not the precise number that emerges from Keeney' s
risk-risk model, is the important thing: spending tax resources to
3Ralph L. Keeney, "Mortality Risks Induced by Economic Expenditures," Risk
Analysis 10 (December 1990): 147-48, 155. A number of newspaper articles and a
report of the General Accounting Office ("Risk-Risk Analysis: OMB's Review of a
Proposed OSHA Rule," July 1992) criticize Keeney's model on the grounds that it
is not conclusive. Of course not. It is preliminary, being the first of its kind, and
exploratory. The GAO report especially is misleading in that it evaluates Keeney's
model against an absolute standard. Compared with the models the Occupational
Health and Safety Administration uses, it stands up very well. A model to test
regulations should be judged by the models used to regulate. But that is another
story.
386
Health and Safety
improve safety may be counterproductive if the physical effort and
cost involved do more harm to health than the good intended.
Conclusion
All of us like to think we are helping, not harming, others. The
so-called helping professions are aptly named, not because mental
health practitioners never do harm, but to accentuate their good
intentions. For instance, I do not doubt the good intentions of the
people employed by the Occupational Safety and Health Adminis
tration. They are persuaded that their mission is to improve safety,
and their disbelief and anger when some fool professor (perhaps
that's an oxymoron) tells them that they may be doing harm is
understandable. But their consternation is unwise. All of us must
take the risk that what we do may have unintended and harmful
consequences. Just as it is the temptation of the powerful to abuse
their power, so it is the temptation of safety advocates to believe
that whatever they do can do no harm. Life teaches otherwise. If
I am not committing lese majesty by suggesting that expenditures
designed to reduce risk may actually increase it, then research on
the conditions under which richer is safer should be undertaken.
Health and safety, to reiterate, are collective achievements.
Immense quantities of evidence correlate both with competitive
capitalist institutions, and there are intriguing rationales that sug
gest the mechanisms through which competition improves health
and safety. When we know enough and are rich enough, we should
adopt protective public health measures. But that degree of knowl
edge is relatively rare. When we are partially or wholly ignorant
of what lies in store, we should not rely on futile anticipation but
rather on competition to separate the harmful from the healthful.
387
r
ZJ. A Free-Market Environmental Vision
Fred L. Smith, Jr. , and Kent Jefes
There is one environmental vision, and only one, that is compati
ble with all other human values. Only a vision that recognizes and
responds to universal human traits will be successful in the long
run. Only a vision that accounts for the reality of individual self
interest can be applied in the real world. Only a vision that sees
value in human diversity as well as ecological diversity can capture
the entrepreneurial potential of the human race. That vision is free
market environmentalism.
America has long been known as a nation where private homes
and backyards are beautiful but politically managed parks and
streets are a mess. For some the answer is to raise taxes to better
support the "cash starved" public sector. For others the answer
will be found in stringent regulations covering every aspect of
modern society. A better approach would be to discover what
makes homes and backyards beautiful and apply the lessons to
problem areas. Rather than bureaucratize the environment, we
should privatize our efforts to protect the environment. In other
words, environmental values must be fully integrated into the free
enterprise system. One might say that trees should not have legal
standing, but behind every tree should stand a private steward, a
private owner, willing and legally enabled to protect that resource.
This vision of an America engaged in creative ecological privatiza
tion may be radical, but it offers great promise of lasting success in
dealing with the ever-changing circumstances of human interaction
with the natural world. Not only is this vision applicable to environ
mental protection, it is compatible with the traditional American
respect for individual liberty.
Myth V5. Reality
Current environmental policies reflect the false assumptions of
the recent past: that the natural environment is benign, that the
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MARKET LIBERALISM
economy can grow without using resources, that once mankind
has touched a wilderness it is forever ruined, and that political
actors can best protect environmental amenities. Of the many erro
neous assumptions, the most widespread has been that stringent
government regulations could eliminate pollution without signifi
cant economic cost. One result of basing policy on that myth has
been the growth of special-interest environmental politics. Special
interest bees will always find the political honey, and the average
citizen will usually get stung. For example, tremendous profits are
available to corporations that capture the regulatory process and
turn it into a barrier to competitors.1
For similar reasons, a strong incentive exists for environmental
groups to find a crisis within each issue, from the nonexistent
health risk to children from pesticide residues on vegetables to the
greatly exaggerated effects of so-called acid rain on forests and
lakes. By constantly claiming that the sky is falling, the environmen
talist Chicken Littles have become geese that lay golden eggs. Con:
tributions from philanthropic foundations and sincerely concerned
individuals are used to purchase political power and to support
massive bureaucratic empires. A mutually beneficial arrangement
has been created among some industries and the environmental
lobbying elite. Presiding over it all is the permanent political class.
Free-market environmentalism seeks to break that triangle by
returning to the principles of self-government and self-reliance
upon which America was founded. The free-market vision is based
on a merger of individual responsibility with individual rights.
Unfortunately, free-market proponents carry the burden of a wide
spread misunderstanding of the history of capitalism. The image
of an uncaring, unresponsive, and ecologically destructive corpora
tion is set against an enlightened and altruistic state that is seen
as the protector of the environment. Capitalism, we are told, causes
pollution.2 Yet for all its problems, capitalism has created a Garden
ISee, for example, Environmental Politics: Public Costs, Private Reards, ed. Fred
L. Smith, Jr., and Michael Greve (New York: Praeger, 1992).
2See, for example, Barry Commoner, Making Peace with the Planet (New York:
Pantheon Books, 1990). For a rebuttal, see Thomas DiLorenzo, "Does Capitalism
Cause Pollution?" Center for the Study of American Business, Washington Univer
sity, St. Louis, August 1990.
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Environmental Vision
of Eden in comparison with what the socialist economies of the
former Soviet bloc created.
The reasons for the socialist failure in the ecological realm are
the same as for socialism's economic disasters. Key aspects included
the state ownership of resources, the bureaucratic decisionmaking
processes, and the denial of private property rights (among other
important liberties). The original (economic) socialists argued that
people would be better off under socialism than they had been
under the previous regime. Although history has proved the oppo
site to be true, many socialist economic tools are being promoted
as the answer to America's environmental problems.
Market Socialism
Because today the victory of market freedom over state tyranny
is a metaphor embraced by all, almost every environmental position
is defended as being "market oriented." Unfortunately, the rhetoric
does not refect the reality. For example, the multi-billion-dollar
Clean Air Act amendments of 1990 contain only a few, almost
insignificant provisions that even touch on market-style arrange
ments for dealing with pollution. Yet those tiny concessions are
eviscerated by simultaneous declarations to the effect that no prop
erty rights will arise from the operation of the act and that federal
confiscation of the fruits of pollution-reducing investment is spe
cifically permitted. That version of market socialism displays the
same flaws detected by Ludwig von Mises and F. A. Hayek in
their debate with the socialist economist Oskar Lange in the 1930s.
Neither side argued that a Soviet-style economy could succeed, but
Lange asserted that tradeable production quotas and state pricing
systems could replicate market efficiencies. Although it is generally
conceded that Hayek and von Mises won that particular debate,
Lange's arguments still strike a responsive chord with government
planners.
To be fair, ecological market socialists also have a vision. It bears
various names, such as "sustainable development" or "ecological
economics." Oddly enough, proponents of those approaches claim
to seek the same goal as free-market environmentalism, that is, a
reconciliation of man and nature. It is more likely, given their heavy
reliance on state-controlled economies, that those approaches
would result in greatly reduced economic performance, reduced
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MARKET LIBERLISM
standards of living, and, eventually, a political backlash. The recent
UN-sponsored Earth Summit in Rio de Janeiro was a perfect exam
ple of how the advocates of the market-socialist approach are
becoming more detached from the average citizen as they spend
more and more of their time meeting and talking with one another
at world-renowned resorts. Little was said in Rio about the real
problems confronting the people of the world: unsafe drinking
water, lack of respect for property rights, government distortion
of markets for food and other commodities, and a "tragedy of the
commons" in forests and oceans. Instead, world "leaders" shared
a platform with Fidel Castro, who was welcomed as an honestly
concerned ecologist.
Regardless of the nomenclature employed by the market social
ists, the goal remains the same: to direct human behavior through
state action. The j ustification of a centralized decision making proc
ess is the assumption that individual humans will often make
"wrong" choices, which will eventually create widespread ecologi
cal catastrophe. That argument more accurately applies to the gov
ernments of the world. Only governments possess the coercive
force necessary to collect revenues for money-losing "develop
ment" schemes. Thus, capitalism has scarcely touched the great
river systems of the world. Most major hydropower projects have
been state sponsored. Even the pollution that flows into rivers has
been the result of the state's neglect of its duty to defend private
rights. Similarly, capitalists mostly ignored the tropical rain forests
until state subsidies for clearing them were introduced. In fact, in
those nations with secure property rights, capitalism plants far
more trees than it cuts. The oceans' living marine resources are at
risk precisely because governments deny private property rights
to wildlife and fish. Those are not examples of the failure of existing
markets; they are examples of the failure to allow markets to exist.
Despite its inherent limitations, market socialism remains (at least
rhetorically) attractive to many because of its emotional appeal.
The forces of "good" government will repel or punish the forces
of "evil" polluters. Unfortunately, real life is rarely so conveniently
black and white. Whenever reality is so clear-cut, free-market envi
ronmentalism detects, deters, and deals with polluters or other
environmental transgressors at least as well as market socialism
does. Free-market environmentalism, like capitalism itself, has not
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Environmental Vision
received full and open consideration in the policy arena, in large
part because, in the political world, utopian lies are often more
useful than realistic assessments of the truth. Absurd accusations
leveled against free-market environmental approaches take on
mythic proportions. One common claim, for example, is that with
out universal government controls, the poor would be buried under
the toxic wastes generated by the wealthy. The irony of state
monopolies' dumping municipal waste in the poorest areas is
apparently lost on the adherents to that myth. The fact is that
enforcing the property rights of the poor would do far more to
protect them from pollution (or crime or any number of other prob
lems) than has, for example, the federal government's $15 billion
hazardous waste cleanup program known as Superfund. Super
fund benefits lawyers, bureaucrats, Environmental Protection
Agency contractors, and environmental lobbyists. Free-market
environmentalism would empower the poor, not profit from-and
then leave them in-their plight.
Using Children as Shields
Perhaps the most pernicious aspersion cast on capitalism is the
claim that it will leave a desolate world as an inheritance for today's
children. That assertion is breathtaking in its boldness. Any rational
assessment of history would declare capitalism the savior of the
world's children. Present, and future, generations have benefited,
not merely in the material goods provided by capitalism, but in
every category of health care and in quality of life. The only subtle
aspect of the depleted-inheritance myth arises when its proponents
occasionally admit that capitalism has improved the situation too
much. World population is growing because far more children live
to adulthood and bear offspring of their own. Eventually, it is
claimed, capitalism will run out of "natural" resources to "deplete, "
and the whole system will come crashing down i n cataclysmic
fashion. That view is as inaccurate as it is apocalyptic. The most
important "natural" resource is the human mind. As long as a
liberal society exists, that resource is inexhaustible and can readily
replace or find substitutes for all other "natural" resources.
The incredible ingenuity of the human mind is the solution, not
the problem. Rather than shackle it, we must free it to create new
miracles. A revealing moment occurred during the brief publicity
393
MARKET LIBERALISM
of so-called cold fusion, which potentially offered limitless, inex
pensive, clean energy to mankind. When asked about the prospects
for future generations if cold fusion turned into a reality, ecological
guru Paul Ehrlich said it would be "like giving a machine gun to
an idiot child," and environmental radical Jeremy Rifkin claimed,
"It's the worst thing that could happen to our planet.
,,
3
It is not much of an exaggeration to say that if human ingenuity
were supplied with unlimited energy, anything would be possible.
Little wonder, then, that the strongest push of the market socialists
is against the increased production or use of energy. "We are run
ning out of fossil fuels" has been a government refrain for over a
century, yet supplies are more plentiful today than ever before, as
Jerry Taylor points out in chapter 21. That inconvenient fact is
rarely admitted in public. No matter, higher taxes will fulfill the
prophecy by creating an artificial scarcity. Thus are our hopes and
aspirations held hostage to environmental extremism.
Capitalism: Beyond Economics
Fortunately, free-market environmentalism is not limited to a
sterile discussion of economic efficiency, contracts, or private prop
ert
y
ri
g
hts. In essence, free-market environmentalism is a reconcili
ation of man and nature. Rather than practice ecological apart
heid-the separation of man from nature-political policy should
rely on the natural incentives of private individuals cooperating
through voluntary associations. Policy should empower millions
of individuals to protect their environment, rather than thousands
of bureaucrats to protect their political turf. It is beyond question
that if the billions of individuals on the earth do not desire to protect
it, the planet is beyond hope. No amount of coercion will save the
planet if the average person truly wants to destroy it. The simple
fact is that people everywhere desire a better life, and a better life
includes a sound and safe environment.
The universal desire for a livable environment is often translated
into an excuse for political action. Because everyone agrees that
something should be done, for example, to reduce pollution, politi
cians feel justified in taking exclusive control of the issue. Yet grant
ing a monopoly on pollution control to the state is like granting
3
Both quotes are from Paul Ciotti, "Fear of Fusion: What if It Works?" Los An
g
eles
Times, Apr 19, 1989.
394
Environmental Vision
government a monopoly on the delivery of mail. Like those of the
government-controlled postal service, the environment-protecting
services provided will generally be slow and unable to respond
to changing circumstances. The costs will generally be high and
extremely resistant to economizing reforms. Important niches will
be either ignored or heavily subsidized. While a basic level of protec
tion may be available under a state ecological monopoly, the rich
diversity of the biosphere cannot be reflected in the dull mirror of
a centralized political system.
In an important regard, today's moral opposition to pollution
can be compared with the anti-slavery movement of the 19th cen
tury. The abolitionists were not opposed to work itself; they were
fighting against involuntary servitude. Forced labor was considered
a violation of an individual's rights, but freely contracted labor
(even if it consisted of the identical tasks) was clearly legitimate.
In similar fashion, pollution should be seen as the violation of an
individual's right to be free from trespass rather than an evil in
and of itself. The situation could be contemplated in advance and
adequate contractual arrangements developed to avoid the involun
tar introduction of a foreign substance to the property of another.
As long as the parties to the agreement properly manage the by
products of their activities, there is no reason for the state to become
a senior partner in every business. The goal of state intervention
should be to prevent or correct coercion of innocent parties. Under
appropriate circumstances, pollution may become a valid concern
of the state, but it is illegitimate for the state to initially sanction
pollution (or slavery) and then condemn capitalism as the source
of the problem.
One of the major criticisms of free-market policies is that the
private sector will never protect the diversity found in nature. In
fact, there are numerous examples of successful private efforts to
preserve environmental amenities, and they deserve far greater
attention than they have received to date.4 The argument against
private-sector protection of natural diversity is also weakened by
the fact that few governments have displayed an ability to balance
their fiscal budgets. It would seem that balancing the ecology is an
4See, for example, Robert J. Smith, 15th Annual Report of the Council on Environmental
Quality (Washington: CEQ, 198), chap. 9, "Special Report: The Public Benefits of
Private Conservation."
395
MARKET LIBERALISM
even more complex undertaking. However, if the state performs
its proper role and protects the private liberties we all hold individu
ally, the environment will greatly benefit. Whenever one individual
succeeds in protecting his property (with its associated environ
mental aspects), a precedent is established. Those precedents
strongly influence the subsequent actions of others, even of parties
unrelated to the original dispute. Relying on centralized govern
ment to address environmental problems may also establish prece
dents, but they are likely to be bad ones. Election year politics,
budgetary constraints, conflicting agency agendas, special-interest
influences, and political selection of priorities all work to make
centralized environmental policy ineffective.
Perhaps the most significant obstacle to the adoption of alterna
tives to centralized control over the environment is a widely held,
if greatly exaggerated, fear of impending ecological catastrophe. In a
crisis, real or perceived, people have a natural tendency to demand
emergency accommodations. As mentioned earlier, preying upon
the natural concern that parents have for their children has become
a major preoccupation of the environmental movement in recent
years, from the Alar-treated apple hoax to the end-of-the-world
global-warming fantasies. In each case, the concern is not so much
for the present as it is for some indeterminate future. Because it is
extremely difficult to refute vague assertions of far-off disaster, new
panics can be manufactured much faster than old ones can be laid
to rest. The result is a layer cake of half-baked state policies made
according to a market-socialist recipe.
Popular myths are perpetuated by many who know better, and
free-market environmentalists must continue to rebut those science
fiction scenarios. Widespread concern for the environment is being
used to move large segments of the population to action. If that
action is limited to the voting booth, casting a ballot for the "green
est" candidate, little more than market socialism can be expected
to result. But if the same people were encouraged to accept respon
sibility for their own backyards, a tremendous number of diverse
improvements could be made. Even if it could be shown that a
food of biblical proportions was likely, we should avoid building
a huge state "ark" to shelter politically preferred environmental
amenities. Instead, America should become a land of millions of
small arks, each tended by individuals or voluntary organizations
396
Environmental Vision
and thus better able to preserve and protect the diversity of the
natural world.
For public agencies to deal with the full range of ecological niches
and changing circumstances found in nature, constant fine-tuning
of the bureaucratic mechanism is needed, yet bureaucracies are
notoriously difficult to fine tune. In contrast, free markets are natu
rally self-correcting and every transaction is an act of fine-tuning.
Unfortunately, because of the prevalent myths, the actual results of
capitalism are compared with the stated intentions of government
policies. The risks to future generations arise not from exposure to
capitalism but from exclusion fom it.
Property Rights
Free-market environmentalism, like capitalism itself, is depen
dent on private property rights. Those rights must be well defined,
well defended, and voluntarily transferable. When those prerequi
sites exist, competitive capitalism becomes a remarkable efficiency
generator. The desire for profit leads directly to the elimination of
waste. Pollution is generally some form of waste, but even if pollu
tion were unavoidable in certain manufacturing processes, strongly
enforced property rights would force polluters to either clean up or
close shop. By definition, pollution is a trespass against someone's
property or person. If the trespass is so minor that it creates no
impact or inconvenience for the property owner, it will normally
be tolerated, even under common law rules. Today's pollution
dilemma is the result of what is essentially a universal "easement"
granted by the state to polluters, even producers of significant and
damaging pollution. The debate now revolves around how best to
gradually restore their original right (to be free of the trespass of
pollution) to citizens. The first question that should be asked is
not, Why does capitalism destroy the environment? It is, Why isn't
everything already polluted or destroyed? The answer is that the
same private property rights that form the basis for capitalism also
stand as a bulwark against environmental degradation.
It should be remembered that property rights are basically a
voluntary ordering system for resources in a human society. When
ever private property rights have been respected within a society,
the ecological outcome has been superior to that under state owner
ship of resources. Even vaunted state "successes," such as Yellow
stone National Park, are rarely as successful as claimed. Consider
397
MARKET LIBERALISM
that state policies led directly to the disastrous forest fires of 1988
and the quiet devastation of continuing management practices. 5
In contrast, the successes of capitalism are so ubiquitous and
taken for granted that they are rarely acknowledged. Efficiencies
and improvements in resource use, dramatic increases in life spans
and living standards, and the vast private wealth that undergirds
the massive governmental structure are key examples. Unfortu
nately, many of the accomplishments of capitalism are touted as
the results of state manipulation of the economy. Failure to recog
nize the primary importance of capitalism is not of interest only to
historians. Unless it is understood that capitalism must come first,
other nations may adopt American-style environmental policies
with disastrous consequences. Some, especially the nations of East
ern Europe, are already being encouraged to do so. Yet the U.S.
approach to environmental policy cannot possibly be exported to
most countries. It relies on legions of experienced management
personnel and tremendous amounts of capital to meet the high
costs of the mandated technologies. In addition, a highly trained
and fairly honest bureaucracy must be in place. Watchdogging
the entire apparatus are nongovernmental organizations, especially
environmental lobbying groups and the print and broadcast media.
If that is to be the initial paradigm for the developing countries,
they may have to wait decades to deal successfully with ecological
questions. However, they are unlikely to wait that long before they
implement environmental programs. Thus, it is vitally important
that accurate information and workable solutions, tailored to local
conditions, be made available to policymakers. The current sense
of urgency created by the constant barrage of environmental scare
stories is likely to produce the same types of inappropriate policies
across the globe that it has here at home.
Risks
The fact is that most of the urgency imparted to environmental
policy is unnecessary. Where there is a serious problem, a chemical
5For a discussion of the general failure of federal poliCies in Yellowstone, see The
Yellowstone Primer: Lnd and Resource Management in the Greater Yellowstone Ecosystem,
ed. John A. Baden and Donald Leal (San Francisco: Pacific Research Institute, 1990).
See also Alston Chase, Playing God in Yellowstone: The Destruction of America's First
National Park (Boston: Atlantic Monthly Press, 1986).
398
Environmental Vision
spill, for example, there really is no debate over whether a problem
exists. However, environmental policy today has shifted its focus
from risks with immediate and measurable impacts to those with
small (if any) impacts that are, at the very least, far off in the future.
Bureaucrats and their political bosses have powerful incentives
to regulate highly visible or publicized risks, even when few indi
viduals are actually exposed to the risk and the costs of regulation
are high. Such regulation often results in shifting greater risks to
unseen, or un publicized, segments of society. Society as a whole
is no better off; generally, it is worse off.
Many people are enticed (or even required) to dedicate excessive
resources to risk avoidance because of the fashion in which the
options are presented. If the choice is between saving a life and
spending money, almost everyone would vote to save the life. Yet
the truth, in many cases, is that focusing too many resources on a
small risk factor necessarily reduces other, equally important risk
avoidance efforts. Thus, the real choice is between reducing this
risk or reducing that risk. Lives may be at stake on each side of the
equation, as Aaron Wildavsky points out in chapter 2.
Furthermore, in some situations, the only lives at stake are those
put at risk by the environmental policy itself. The anti-asbestos
hysteria whipped up by assertions that a single asbestos fiber could
cause lung cancer led to many unnecessary and even dangerous
asbestos removal efforts. Recently, a federal court declared that the
fuel efficiency requirement for automobiles was directly related to
increased highway injuries and fatalities because it resulted in the
production of smaller, lighter vehicles that are inherently less safe
than larger, heavier models.6 In such situations, individuals have
a paramount right to make critical personal choices for themselves
and their families.
Conclusion
We have seen that pollution is not a failure of markets but a
failure of government to permit private individuals to protect their
property and persons against trespass. Free-market environmental
ism offers a solution to the problem. Also, when government
6
Competitive Enterprise Institute v. National Highway Trafc Safety Administration,
956 F.2d 321 (D.C. Cir. 1992).
399
MARKET LIBERALISM
imposes a single risk standard on society in general, many individu
als in particular may be harmed. Again, free-market environmental
ism would enable individuals to assume (or reject) certain risks
without imposing additional risks on other individuals.
Some argue that free-market environmentalism entails excessive
transaction costs, that is, the costs of time and resources dedicated
to negotiating specific arrangements between parties. Therefore, it
is claimed, government should step in and impose uniform stan
dards. Efficiency is an important consideration, especially when
costs are being imposed against the will of the people who will
bear them. However, efficiency is not the only consideration. The
best example may be the court system, which is anything but effi
cient. Society recognizes that human liberty is an overriding con
cern and, therefore, accepts lowered efficiency in order to preserve
a greater good. Some environmentalists have tried to raise a similar
argument with the claim that the intrinsic value of an ecological
asset can override the liberty of the individual. That argument is
a dangerous weapon to place in the hands of any state, for it is as
likely to be abused as it is to be applied carefully. Fortunately, that
line of thinking is inappropriate in light of the fact that modern
technologies are constantly reducing the transaction costs involved
in negotiating, monitoring, and enforcing environmental arrange
ments.
If free-market environmentalism is to be widely accepted, it must
occupy the moral high ground. To a certain degree it has already
done so, although often by default on the part of its detractors.
However, merely paying lip service to the efficiency of markets is
not enough. Free-market environmentalists must strive to demon
strate the superiority of voluntary markets in a host of ecological
niches. Because most of the threatened resources, from wildlife to
wetlands, from airsheds to oceans, are held and managed by politi
cal bureaucracies, they remain at risk. It will be necessary to move
more of those resources, along with the direct responsibilities of
stewardship, into private hands before clear-cut examples become
commonplace.
Some environmentalists see limits to free markets at every turn.
Yet those same individuals see no limits to government. Past envi
ronmental policies have been designed as if politically directed
400
Environmental Vision
resources automatically become unlimited. Those environmental
ists' excessive faith in government is as unwarranted as their vis
ceral opposition to private ownership of resources. The free-market
environmental vision does not purport to eliminate the state (or
state involvement); it merely limits it to an appropriate role.
America needs to take several steps to develop an effective and
sustainable environmental policy. First and foremost, Congress and
the new administration should begin to restore private property
rights in and to environmental resources. Critical ecological ameni
ties should be removed from public hands and conserved through
private stewardship arrangements. The details will vary among,
and even within, resources. For example, one end of a coral reef
might be managed by recreational fishermen while another portion
was managed by a diving club. Particular stretches of rivers might
be leased to fishing clubs while tracts of forest could be owned by
hiking, hunting, or camping organizations. Any harm to the rivers
or forests from external forces could be dealt with through contrac
tual obligations and, if necessary, tort law.
Although strong incentives to conserve resources will be gener
ated through private ownership, it is also important to eliminate
perverse incentives. The federal government provides subsidies to
many activities through direct transfers as well as through the
provision of free or below-cost access. For example, recreational
activities in the national forests and parks are heavily subsidized;
most users pay low (or no) fees. Such subsidies encourage people
to "consume" more of those public resources than they would be
likely to in a market system. In addition, subsidies for favored
providers of environmental amenities tend to squeeze out private
alternatives. Other well-known subsidies that can unintentionally
degrade the environment include agricultural subsidies, grazing
subsidies, and water and hydropower project subsidies, among
others. Unfortunately, the political process finds it almost impossi
ble to deal honestly with the issue of subsidies. Only free markets
are able to assess the full costs of resource use. Until property
rights-based policies are instituted, environmental issues-from
waste disposal to wetlands protection-will be poorly managed.
For most Americans, environmentalism is an important value,
but it is not the only one. Jobs, housing, health care, education,
national defense, and other values make demands on the resources
41
MARKET LIBERLISM
of the individuals who constitute society. Like it or not, ecological
purity must compete with other objectives. Therefore, a responsible
policy must allow individuals to make choices for themselves, con
sistent with the rights of others. In the final analysis, to be compati
ble with the full array of individual values, environmental policy
must adopt a free-market approach.
402
Contributors
Doug Bandow is a senior fellow at the Cato Institute.
David Boaz is executive vice president of the Cato Institute.
Ted Galen Carpenter is director of foreign policy studies at the
Cato Institute.
Edward H. Crane is president of the Cato Institute.
Bert Ely is the principal of Ely & Company, a financial institutions
consulting company.
Jeffrey R. Gerlach is a foreign policy analyst at the Cato Institute.
Thomas W. Hazlett teaches economics and public policy at the
University of California, Davis, and in 1991-92 was visiting chief
economist at the Federal Communications Commission.
Kent Jeffreys is director of environmental studies at the Competi
tive Enterprise Institute.
Christopher Layne teaches international relations at UCLA and is
a senior fellow of the Cato Institute.
Brink Lindsey is director of regulatory studies at the Cato Institute.
Stephen Moore is director of fiscal policy studies at the Cato Insti
tute.
Patrick J. Michaels is associate professor of environmental sciences
at the University of Virginia, senior fellow in environmental studies
at the Cato Institute, and author of Sound and Fury: The Science and
Politics of Global Warming.
William A. Niskanen is chairman of the Cato Institute and editor
of Regulation magazine.
Lewis J. Perelman is a senior fellow at the Discovery Institute and
author of School's Out: Hyperlearning, the New Technology, and the
End of Education.
403
MARKET LIBERALISM
Roger Pilon is director of the Cato Institute's Center for Constitu
tional Studies.
Robert W. Poole, Jr., is president of the Reason Foundation.
A. Haeworth Robertson is president of the Retirement Policy Insti
tute, former chief actuary of the Social Security Administration,
and author of Social Security: What Every Taxayer Should Know.
Fred L. Smith, Jr., is president of the Competitive Enterprise Insti
tute.
Melanie S. Tammen is an adjunct scholar of the Cato Institute.
Michael Tanner is director of research at the Georgia Public Policy
Foundation.
Jerry Taylor is director of natural resource studies at the Cato
Institute.
Ian Vasquez is assistant director of the Cato Institute's Project on
Global Economic Liberty.
Aaron Wildavsky is Class of 1940 Professor of Political Science and
Public Policy at the University of California, Berkeley.
404
LlO HSlilUlC
Founded in 1977, the Cato Institute is a public policy research
foundation dedicated to broadening the parameters of policy debate
to allow consideration of more options that are consistent with the
traditional American principles of limited government, individual
liberty, and peace. To that end, the Institute strives to achieve
greater involvement of the intelligent, concerned lay public in ques
tions of policy and the proper role of government.
The Institute is named for Cato's Letters, libertarian pamphlets
that were widely read in the American Colonies in the early 18th
century and played a major role in laying the philosophical founda
tion for the American Revolution.
Despite the achievement of the nation's Founders, today virtually
no aspect of life is free from government encroachment. A pervasive
intolerance for individual rights is shown by government's arbitrary
intrusions into private economic transactions and its disregard for
civil liberties.
To counter that trend, the Cato Institute undertakes an extensive
publications program that addresses the complete spectrum of pol
icy issues. Books, monographs, and shorter studies are commis
sioned to examine the federal budget, Social Security, regulation,
military spending, international trade, and myriad other issues.
Major policy conferences are held throughout the year, from which
papers are published thrice yearly in the Cato Journal. The Institute
also publishes the quarterly magazine Regulation and produces a
monthly audiotape series, "Perspectives on Policy. "
I n order t o maintain its independence, the Cato Institute accepts
no government funding. Contributions are received from founda
tions, corporations, and individuals, and other revenue is gener
ated from the sale of publications. The Institute is a nonprofit,
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CA TO INSTITUTE
224 Second St. , S. E.
Washington, D. C. 20003
(continued from front /ap)
and economic activities. Any viable agenda
for the 21st centur must recognize the truth
that al central planning, whether for educa
tion, medical care, or the environment, will
only end in failure. Market Liberalism pre
sents a new vision for Ameritan goverent,
a positive, optimistic vision rooted in the prin
ciples of the Founders and suited to the chal
lenges of the 21st century. It offers the
promise of a fee, prosperous, and pluralistic
society for America and the world.
David Boaz is executive vice
president of the Cato
Institute.
Edward H. Crane is
president of the Cato
Institute.
Cato Institute
224 Second Street, S.E.
Washinton, D. C. 20003
\ " 10Ul
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9
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